Callable convertible bonds under liquidity constraints and hybrid priorities

TL;DR

This paper models callable convertible bonds with liquidity constraints and hybrid priorities, providing a complete solution and introducing a new technique for non-ordered Dynkin games, expanding understanding of complex financial decision problems.

Contribution

It generalizes previous models by incorporating hybrid priorities and liquidity constraints, and develops a novel method for solving non-ordered Dynkin games in this context.

Findings

Derived a complete solution for the hybrid priority callable convertible bond problem.

Introduced a new technique for non-ordered Dynkin games applicable to financial models.

Extended existing models to include liquidity constraints and partial priorities.

Abstract

This paper investigates the callable convertible bond problem in the presence of a liquidity constraint modelled by Poisson signals. We assume that neither the bondholder nor the firm has absolute priority when they stop the game simultaneously, but instead, a proportion $m\in[0,1]$ of the bond is converted to the firm's stock and the rest is called by the firm. The paper thus generalizes the special case studied in [Liang and Sun, Dynkin games with Poisson random intervention times, SIAM Journal on Control and Optimization, 57 (2019), 2962-2991] where the bondholder has priority ($m=1$), and presents a complete solution to the callable convertible bond problem with liquidity constraint. The callable convertible bond is an example of a Dynkin game, but falls outside the standard paradigm since the payoffs do not depend in an ordered way upon which agent stops the game. We show how to deal with this non-ordered situation by introducing a new technique which may be of interest in its own right, and then apply it to the bond problem.