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Korean J Financ Stud > Volume 46(4); 2017 > Article
Korean Journal of Financial Studies 2017;46(4):947-965.
DOI: https://doi.org/10.26845/KJFS.2017.    Published online September 30, 2017.
Pricing a Defaultable Convertible Bond by Simulation
Keehwan Park, Mookwon Jung, Sangki Lee
Pricing a Defaultable Convertible Bond by Simulation
KeehwanPark, MookwonJung, SangkiLee
In this study, we offer a simple way to price a defaultable, convertible, and callable bond by applying the Longstaff-Schwartz Least Squares simulation method. In our model, the stock price is a driving force for valuing the security. A key idea is to terminate the simulated sample path immediately when the issuer defaults on the bond at time t, the same as when the investor and the issuer optimally exercise their option, and to discount back the resulting cash flows at a risk-free rate. In turn, the defaulted group of the sample paths belongs to a bottom x percentile of the realized stock prices at each time, which is exogenously given by the cumulative or marginal default probability of a firm equally rated as the issuer. We apply our simulation model to a zero-coupon, callable, convertible and defaultable bond and show that the price depends on its default probability and recovery ratio.
Key Words: Least Squares Simulation,Optimal Decision Rule,Marginal Default Probability,Recovery Ratio,Default-Triggering Stock Price Level,최소자승 시뮬레이션,최적 의사결정 규칙,한계부도확률,회수율,부도주가수준
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