Reverse Convertible Bonds Analyzed
Journal of Futures Markets, Vol. 29, No. 10, pp. 895-919, 2009
31 Pages Posted: 7 Sep 2006 Last revised: 28 Mar 2012
Date Written: December 19, 2008
Abstract
We study the pricing of reverse convertible bonds. These are bonds that carry high coupon payments. In exchange, the issuer has an option at the maturity date to either redeem the bonds in cash, or to deliver a pre-specified number of shares. We find that Dutch plain vanilla and knock-in reverse convertible bonds are, on average, overpriced by almost 6%. This overpricing is confirmed in a model-free analysis with respect to option and bond pricing models. We find that rational factors explain 23% of the documented overpricing. In addition, we find that the combination of financial marketing, framing, and the representativeness bias further increases our ability to explain the documented overpricing to more than 35%.
Keywords: reverse convertible bonds, reverse exchangeable securities, structured products
JEL Classification: G10, G19
Suggested Citation: Suggested Citation
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