The purpose of this thesis is to present a comprehensive empirical study on convertible bond valuation. It takes 34 samples of Euro-convertible bonds from UK and US corporations with more than 40,000 daily trading prices to investigate the convertible bond pricing behavior. We derive a new convertible bond valuation method with incorporation of credit risk premium through hedging argument. Not only does this method show improvement over the model of McConnell and Schwartz [26], but it also avoids an unsolved problem that Merton's Contingent Claim Approach does not seem to adequately model the high level of observed credit risk premium in real life. Using our model, we estimate the Implied Credit Risk Premium (ICRP) from each convertible bond series. Through the comparison between the im...[ Read more ]

The purpose of this thesis is to present a comprehensive empirical study on convertible bond valuation. It takes 34 samples of Euro-convertible bonds from UK and US corporations with more than 40,000 daily trading prices to investigate the convertible bond pricing behavior. We derive a new convertible bond valuation method with incorporation of credit risk premium through hedging argument. Not only does this method show improvement over the model of McConnell and Schwartz [26], but it also avoids an unsolved problem that Merton's Contingent Claim Approach does not seem to adequately model the high level of observed credit risk premium in real life. Using our model, we estimate the Implied Credit Risk Premium (ICRP) from each convertible bond series. Through the comparison between the implied credit risk premium from convertible bond and the credit risk premium from non-convertible straight corporate bond under similar credit rating class, we test the efficiency of the convertible bond market. This paper also investigates the relationship between the movement of the implied credit risk premium with some macro-economic and firm-specific factors. We find that the credit ratings from S&P and Moody's have very strong explanatory power on the credit risk premium of convertible bond. In fact, the credit risk premium of convertible bond is roughly the same as that of straight corporate bond under the same credit rating class. In addition, the required credit risk premium of convertible bond is changing with the macro-economic environment and the firm-specific situation. A negative relationship with issuer's stock price and a positive relationship with market interest rate are reported.