Posted by
John Maiden on
Jun 22, 2007; 2:49pm
URL: http://quantlib.414.s1.nabble.com/Proposed-change-to-Convertible-Bond-model-tp9499p9500.html
Two things I noticed about the existing convertible bond model that I think
needs to be changed:
1. All the dividends that are added back to the stock price in
DiscretizedConvertible are the clean price, and need to be adjusted back at the
risk free rate. Changes would be:
- In class DiscretizedConvertible (DiscretizedConvertible.hpp), add a new
DividendSchedule (I call it dirtyDividends_)
- In Disposable<Array> ExtendedDiscretizedConvertible::adjustedGrid() const
(DiscretizedConvertible.cpp), the pointer d is now const
boost::shared_ptr<Dividend>& d = dirtyDividends_[i];
I've checked this, and the effect on the price in minimal, but there is a
definite change.
2. Probabilities in the Tsiveriotis-Fernandes Lattice (tflattice.hpp) that are
used to weigh the lattice values are fixed, and independent of the tree used.
For some reason pu_ and pd_ are set to Cox-Ross-Rubinstein probabilities. The
constructor for the TFLattice should now have the following code:
dt_ = end/steps;
pd_ = tree->probability(0,0,0);
pu_ = tree->probability(0,0,1);
riskFreeRate_ = riskFreeRate;
creditSpread_ = creditSpread;
QL_REQUIRE(pu_<=1.0, "negative probability");
QL_REQUIRE(pu_>=0.0, "negative probability");
This has a major effect on the prices. Before, using the example provided, there
was a huge spread between values for different trees. Now the different trees
produce much less spread (the difference is around 0.10 instead of the previous
10.00).
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