Convertible Bond Underpricing: Renegotiable Covenants, Seasoning and Convergence (Published in "Management Science", Vol. 53, No. 11, November 2007, pp. 1793.1814. )

Alex W.H. Chan and Nai-fu Chen
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Alex W.H. Chan: School of Economics and Finance, University of Hong Kong
Nai-fu Chen: Center for Advanced Research Finance, University of Tokyo

No CARF-F-075, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: We investigate the long-standing puzzle on the underpricings of convertible bonds. We hypothesize that the observed underpricing is induced by the possibility that a convertible bond might renegotiate on some of its covenants, e.g., an imbedded put option, in financial difficulties. Consistent with our hypothesis, we find that the initial underpricing is larger for lower rated bonds. The underpricing worsens if the issuer experiences subsequent financial difficulties. However, conditional on no rating downgrades, our main empirical result shows that convertible bond prices do converge to their theoretical prices within two years. This seasoning period is shorter for higher rated convertible bonds.

Pages: 61 pages
Date: 2006-10
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