Convertible bond valuation with regime switching ez

Abstract

We present a valuation formula for convertible bonds with regime-switching market conditions by de-composing the convertible bond into a coupon-bearing bond and the American-type exchange option. A coupon-bearing bond component is modeled with a four-factor model: a two-factor affine model for the risk-free rate and a two-factor affine model with stochastic volatility for the credit spreads on the coupon-bearing bond component. We also derive a new valuation formula for the American-type exchange option component. (c) 2021 Elsevier Ltd. All rights reserved.