Valuation and Optimal Strategies of Convertible Bonds

This paper presents a contingent claim valuation of a callable convertible bond with the issuer's credit risk. The optimal call, voluntary conversion and bankruptcy strategies are jointly determined by shareholders and bondholders to maximize the equity value and the bond value, respectively. Our model not only incorporates tax benefits, bankruptcy costs, refunding costs and a call notice period, but also takes account of the issuer's debt size and structure. The numerical results show that the predicted optimal call policies are generally consistent with recent empirical findings; therefore calling convertible bonds too late or too early can be rational