Pricing Convertible Bonds Based on Compound Option Model

This paper presents a new pricing approach for convertible bonds based on multi-stage compound option model.Building the governing partial differential equation and proposing the corresponding boundary conditions and terminal conditions,this paper solves the governing equations by finite differential method to avoid the calculation of nested high dimensions integrals.The result shows that popular pricing approach,which decomposes convertible bonds into European option and bonds,underestimates significantly value of convertible bonds,and the compound option pricing approach is more consistent with the practice.