Past Mathematical Finance Seminar

17 June 2005
A firm issues a convertible bond. At each subsequent time, the bondholder must decide whether to continue to hold the bond, thereby collecting coupons, or to convert it to stock. The bondholder wishes to choose a conversion strategy to maximize the bond value. Subject to some restrictions, the bond can be called by the issuing firm, which presumably acts to maximize the equity value of the firm by minimizing the bond value. This creates a two-person game. We show that if the coupon rate is below the interest rate times the call price, then conversion should precede call. On the other hand, if the dividend rate times the call price is below the coupon rate, call should precede conversion. In either case, the game reduces to a problem of optimal stopping. This is joint work with Mihai Sirbu.
  • Mathematical Finance Seminar