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Valuation of Bonds with Embedded Options on Russian Market
Fixed income instruments and, especially, bonds are used all over the world as relatively conservative part of investment portfolios. Among all the kinds of bonds, bonds with embedded options arouse the special interest. The option part provides investors with protection from downside price movements, which makes it possible to increase investment activity is this kind of instruments. The purpose of this paper is to describe the procedure of fair valuation of bonds with embedded options in low liquidity Russian bond market as well as find special characteristics affecting option adjusted spreads. In this paper we have evaluated the price of Russian corporate bonds with embedded options by using two different interest rates model – the Vasicek and Hull – White model. It was shown that the Hull – White model provides better fit to the observed market prices of bonds with embedded options and OASs are in the vast majority of cases equal to zero. In contrast, the Vasicek model provides poorer fit, but the prices can be corrected by adding smaller OASs. It was also shown, that credit quality and liquidity can be the important factors affecting the OASs for Russian corporate bonds. Finally, it was also shown that the fair price of the vast majority of embedded options in the Russian market is zero.