The singularity-separating method for two-factor convertible bonds

You-lan Zhu and Yingjun Sun

Abstract

ABSTRACT

If a convertible bond is on a stock paying a continuous dividend or if a convertible bond has a call or a put feature, then fast and accurate pricing of such a bond is somewhat difficult, because the problem involves free boundaries. Recent work has shown that the singularity-separating method of Zhu and co-workers can very quickly give highly accurate solutions of American options, which also involve free boundaries. In this paper, the authors generalize this method, so that two-factor convertible bonds with such features can be evaluated in a similar way.