FIN-02-048 |
NYU Stern School of Business |
Pricing inflation-indexed convertible bonds with credit
risk
October 2002
Yoram Landskroner and Alon Raviv
ABSTRACT
In Issuing convertible bonds has become a popular way of raising capital by corporations in
the last few years. An important subgroup is convertibles linked to a price index or
exchange rate.
The valuation model of inflation-indexed (or equivalently foreign-currency) convertible
bonds derived in this paper considers two sources of uncertainty allowing both the
underlying stock and the consumer-price-index to be stochastic and incorporates credit
risk in the analysis. We approximate the pricing equations by using a Rubinstein (1994)
three-dimensional binomial tree, and we describe the numerical solution. We investigate
the sensitivity of the theoretical values with respect to the characteristics of the issuer, the
economic environment and the security’s characteristics (number of principal payments).
Moreover, we demonstrate the usefulness and the limitations of the pricing model by
using inflation-indexed and foreign-currency linked convertibles traded on the Tel- Aviv
stock exchange.
JEL Classification: G12, G13
Yoram Landskroner
Institution: Stern School of Business, New York University, 44 West 4th Street, New York, NY 10012
Telephone: (212) 998-0913
Fax: (212) 995-4233
Email: ylandskr@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~ylandskr
Alon Raviv
Institution: School of Business, Hebrew University of Jerusalem, Israel
Email: araviv@stern.nyu.edu
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