Chinese convertible bonds

[Joseph Wang]

I've created a page on the wiki called

http://wiki.quantlib.org/twiki/bin/view/Quantlib/ConvertibleBonds

states the problem.  The basic issue is that the current finite
differencing scheme doesn't include the provision to handle systems of
PDE's.  The brute force method would involve writing a new Evolver which
just runs through FiniteDifferencing, but I think that with some
thought, a more architecturally elegant solution can be found for
handling coupled PDE's.

[hidden email] wrote:

> What are you doing for CNY yield curves ?

The funny thing is that this doesn't seem to matter with the models of
convertible bonds that I've seen.

There are two ways of dealing with convertible bonds.  One looks at them
in terms of view of the firms cash flow.  The other involves essentially
treating the bond as an equity option.  The weird thing is that in
neither of these two cases does the yield curve enter into the picture.  
It doesn't seem intuitively right that the yield curve doesn't enter
into this, but I suspect that the reason it doesn't is that convertible
bonds in the West tended to be issued very much out of the money so
people are more concerned with credit risk than they are with interest
rate risk.  Whether this makes any sense with Chinese convertible bonds
is part of what I'm trying to figure out.

>  
> It wasn't clear to me that even CGB's can be reasonably priced with
> the "Hongding" yield curves- liquidity is a bear. Do you know actually
> know traders who can take advantage of mispricing on convertible bonds
> in China ? Do they even do that for CGB's ?

Actually I was after something different.  In the West, the value of
firms are generally more or less known, and the use of quantitative
methods is used mainly to look for artibitrage opportunities.  What I'm
interested in is to see if quantitative finance methods can be used to
get at the market value of Chinese SOE's based on value of the
securities that the firms issue.  In the West, this is a no-brainer
since you can get from share price to a good estimate of the value of a
company.  In Chinese companies, you can't do this very well.  The stock
markets are probably way overpriced, and there are four types of very
different shares in your typical SOE (state shares, LP-shares,
listed-shares, employee shares and the listed shares are divided into
A-shares and B-shares each with different properties) with the added
complication that some of the markets for the shares are legally
questionable.  A very large number of SOE's don't even have a
Western-style balance sheet.  So the goal of the research project is to
see if you can go from the market value of the convertible bonds to say
something useful about the value of the company, which is the opposite
direction that people in the West use.

The other area that I'm interested in is to look at the value of
convertible bonds with a view to see if there are any nasty "negative
feedback" issues that people aren't aware of.  The reason interest rates
are more important that credit risk is that credit risk will effect only
one firm while interest rates will affect all firms, and this could
cause systemic problems in thinly trade bond markets (like China).  Or
maybe not.....  I don't think anyone has thought very much about this.

My gut feeling is that issuing convertible bonds in China is safer than
issuing stock because the requirement to pay debt imposes some
discipline on management, but my concern is that because the finance
models for convertible bonds are somewhat rudimentary, that there might
be some nasty surprise in the way that they are being used in China.

>  As for the "sell side",  I don't know what they are doing at Bank of
> China and ICBC, but the 12 joint stockholding banks and the 34 odd
> city level commercial banks have a long way to go before they need to
> price bonds for trading purposes, though the most recent China Banking
> Regulatory Commission mandate on market risk management
> (www.cbrc.gov.cn <http://www.cbrc.gov.cn>) (=BIS96 ) should start
> whipping all banks into shape.

Yup, and part of my research project involves getting models developed
and understood while the Chinese bond market is in its infancy.  Chinese
experience with derivatives has been a very bumpy one, and the
government is (I think correctly) proceeding very slowly on this.  Also
one thing that confuses me how the CBRC and the CSRC interact with
respect to deriviatives.  It's a bit surprising to me to see the CBRC
take the lead in this, but I suspect that has something to do with the
fact that the Chinese government is seeing derivatives first and
foremost in relation to foreign exchange rather than in terms of raising
domestic capital.  (We can talk off line on this some more, if you are
interested.)

Also, I have a more personal reason for being involved in quantlib and
working on this research project.  Late last year, I tried to break into
quantitative finance and interviewed for some securities firms.  After a
while, I got a little frustrated over the fact that the interview
questions were your standard brain teaser questions, and the
interviewers and recruiters seemed to be more interested in asking C++
trivia questions than evaluating my ability to do original research and
actually get working product shipped, and the people who were
interviewing seemed to show a remarkable lack of vision.

Rather than go through that process again, I figure that the best thing
to spend the next year working on useful finance problems, maybe publish
a paper or so, and this will allow me to bypass the HR people.