The Impact of Downward Adjustment Clause on Convertible Bond Pricing Accuracy

This paper investigates the impact of downward adjustment clauses in the
pricing of convertible bonds (CB). Traditional pricing models often rely on the
assumption of perfect markets, overlooking the influence of special clauses on pricing
accuracy. This study constructs a dual-model framework, one incorporating the
downward adjustment clause and the other excluding it, combining Monte Carlo
simulation and Least Squares Monte Carlo (LSM) methods to empirically test the
mechanism of the downward adjustment clause's impact on CB pricing. The results
show that the model with the downward adjustment clause provides pricing results
closer to actual market prices. The mean error of this model is significantly lower than
that of the model without the clause, and it has a smaller standard deviation, indicating
that this model is superior in terms of pricing accuracy and stability. This paper provides
a new perspective on convertible bond pricing in the Chinese market and validates the
importance of embedded clauses in the valuation of financial derivatives.