Convertible bonds traded at prices inconsistent with Black-Scholes option valuations

Evidence

At first the arbitrage activities of the Salomon group had focused exclusively on the United States. But as other countries also began to deregulate their financial systems, arbitrage opportunities began to appear in capital markets overseas. Japan, for example, partially liberalized its financial system in the 1980s, and Salomon became heavily involved in arbitrage involving convertible bonds. (A convertible bond is one that includes an option to exchange it for another asset, in most cases for stock of the corporation that has issued it. Often such bonds trade at prices different from those implied by the value of the option as calculated by Black-Scholes or other models of option pricing.) The bank made almost $1 billion in two years of arbitrage trading of this kind in Japan (Meriwether interview). — Donald MacKenzie, An Engine, Not a Camera, 967

Categorization

• DEFINE: Defines a convertible bond and states that its market price often diverged from option-model implied value — key to the pre-performativity claim.
• XREF: connects to: Black-Scholes legitimized options despite fitting prices only approximately — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 707; Black-Scholes delta hedging fails when indices jump discontinuously or volatility spikes — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 924; Bond pricing lacks a canonical model equivalent to the stock log-normal random walk — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 964 (+3 more)

Broader Connections

• Option pricing theory did not describe markets but remade them in its own image #expands (0.85) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 182
• Organized options trading alone could explain post-model price convergence to Black-Scholes #corroborates (0.80) — Donald MacKenzie, An Engine, Not a Camera, 1153
• The skew’s persistence after 1987 undermines the discovery narrative of option pricing #complicates (0.78) — Donald MacKenzie, An Engine, Not a Camera, 1163