Market undervaluation of risky convertible offerings: Evidence from the airline industry

Abstract

We assess market valuation of airline convertible preferred stocks using a contingent claims valuation model that was extensively tested by Ramanlal et al. (Rev Quant Financ Account 10:303–319, 1998). Our sample consists of 4,096 daily price observations of 11 convertible preferred stocks issued by the U.S. airlines in 1980–1991. For each convertible we estimate daily model prices for 2 years after issuance and compare them with market prices by calculating pricing errors. While the entire sample’s mean pricing error is found to be negative 3.8%, the panel data analysis and the mean pricing errors of the sub-samples indicate that the undervaluation is much more severe in the first 6 months of trading. The results suggest that airlines leave about 10% on the table when they raise capital by issuing convertible securities.