Publication detail

Valuation of embedded options in non-marketable callable bonds: a new numerical approach

SKALICKÝ, R. ZINECKER, M. BALCERZAK, A. PIETRZAK, M. ROGALSKA, E.

Original Title

Valuation of embedded options in non-marketable callable bonds: a new numerical approach

Type

journal article in Web of Science

Language

English

Original Abstract

The issue of how to price options embedded in callable bonds has attracted a lot of interest over the years. The usual bond valuation methods rely on yield curves, risk premium, and other parameters to estimate interest rates used in discounted cash flow calculations. The option to retire the bond is, however, neglected in the standard pricing models, causing a systematic overvaluation of callable bonds. In the event of a decline in interest rates, investors are exposed to the risk of a lower return on investment than indicated by the yield to maturity. We propose a novel approach to valuing the risk that the issuer will use the right to buy back the bond at a specific call price. While prior models are focused on valuing marketable callable bonds, we deliver a unique approach to valuing bonds with an embedded European option (or a multiple option) that are traded solely through private transactions. These can typically be characterized by the lack of historical records on transaction prices. The modular character of calculation we propose allows us to take into account additional information, such as probable behaviour of the issuer, available opportunities for achieving alternative earnings or different estimates in terms of interest rate development.

Keywords

non-marketable callable bonds, options embedded in bonds, embedded options valuation, option pricing, bond pricing, loss of interest income, interest rate volatility, probability of call

Authors

SKALICKÝ, R.; ZINECKER, M.; BALCERZAK, A.; PIETRZAK, M.; ROGALSKA, E.

Released

24. 7. 2022

Publisher

Vilnius Gediminas Technical University

Location

Vilnius

ISBN

2029-4913

Periodical

Technological and Economic Development of Economy

Year of study

28

Number

4

State

Republic of Lithuania

Pages from

1115

Pages to

1136

Pages count

22

URL

https://journals.vilniustech.lt/index.php/TEDE/article/view/17060

Full text in the Digital Library

http://hdl.handle.net/11012/208227

BibTex

@article{BUT178771,
  author="Roman {Skalický} and Marek {Zinecker} and Adam Przemyslaw {Balcerzak} and Michał Bernard {Pietrzak} and Elzbieta {Rogalska}",
  title="Valuation of embedded options in non-marketable callable bonds: a new numerical approach",
  journal="Technological and Economic Development of Economy",
  year="2022",
  volume="28",
  number="4",
  pages="1115--1136",
  doi="10.3846/tede.2022.17060",
  issn="2029-4913",
  url="https://journals.vilniustech.lt/index.php/TEDE/article/view/17060"
}