The long and the short of convertible arbitrage: An empirical examination of arbitrageurs’ holding periods (original) (raw)
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The Rise and Demise of the Convertible Arbitrage Strategy
Financial Analysts Journal, 2009
This paper analyzes convertible arbitrage, one of the most successful hedge fund strategies. We start by identifying convertible arbitrage activities. We find convertible bonds to be underpriced at the issuance dates. At the same time, short sales of underlying equity significantly increase. Both effects are stronger and more persistent for equity-like than for debt-like convertibles. Although convertible arbitrage positively affects markets by providing liquidity, we argue that short sales pressures negatively affect both shareholders and existing bondholders. An investigation of the determinants of convertible arbitrage returns shows that, over a one-year period following the issue, equity-like convertibles earn a return that is more than 20 percentage points higher than the return of debt-like convertibles. In recent years the returns from convertible arbitrage have strongly decreased, because the universe of issuers shifted from the issuance of equity-like to debt-like convertibles.
Risk and return in convertible arbitrage: Evidence from the convertible bond market
2010
In this paper, we identify and document the empirical characteristics of the key drivers of convertible arbitrage as a strategy and how they impact the performance of convertible arbitrage hedge funds. We show that the returns of a buy-and-hedge strategy involving taking a long position in convertible bonds ("CBs") while hedging the equity risk alone explains a substantial amount of these funds' return dynamics. In addition, we highlight the importance of non-price variables such as extreme market-wide events and the supply of CBs on performance. Out-ofsample tests provide corroborative evidence on our model's predictions. At a more micro level, larger funds appear to be less dependent on directional exposure to CBs and more active in shorting stocks to hedge their exposure than smaller funds. They are also more vulnerable to supply shocks in the CB market. These findings are consistent with economies of scale that large funds enjoy in accessing the stock loan market. However, the friction involved in adjusting the stock of risk capital managed by a large fund can negatively impact performance when the supply of CBs declines. Taken together, our findings are consistent with convertible arbitrageurs collectively being rewarded for playing an intermediation role of funding CB issuers whilst distributing part of the equity risk of CBs to the equity market.
The buyers' perspective on security design: Hedge funds and convertible bond call provisions
We provide evidence that security design reflects the interplay of capital supplier and security issuer preferences. While call provisions have historically been the default option in convertible security design, only a minority of post-2005 issues are callable. Because hedge funds dominate the market for new convertibles today and because convertible arbitrage is less risky without callability, the recent diminution in the frequency of call provisions in new convertible bond issues illustrates the importance of the preferences of the suppliers of capital in security design.
The convertible arbitrage strategy analyzed
This paper analyzes convertible bond arbitrage on the Canadian market for the period 1998 to 2004. Convertible bond arbitrage is the combination of a long position in convertible bonds and a short position in the underlying stocks. Convertible arbitrage has been one of the most successful strategies of hedge funds. This paper shows that the convertible arbitrage strategy has considerable effects on capital markets. First, there is a downward pressure on cumulative average abnormal returns of the underlying stocks between the announcement and the issuance dates of convertible bonds. Second, short sales of the underlying equity around the issuance dates strongly increase for equity-like convertibles. Third, convertible bonds are underpriced at the issuance dates. All effects are stronger for equity-like than for debt-like convertible bonds. Finally, we find that over a one-year period following the issue, equity-like convertibles earn a return that is more than 23 percentage points hi...
We study convertible bond arbitrage for the Canadian market. Convertible bond arbitrage is the combination of a long position in underpriced convertible bonds and a short position in the underlying stock. First, we find a downward pressure on cumulative average abnormal returns of the underlying stocks between the announcement and the issuance dates of the convertible bonds. This effect is strongest for equity-like convertible bonds. Second, we find that the convertible bonds are underpriced at the issuance dates, with the equity-like convertibles being more underpriced than debt-like convertible bond issues. Third, we find increased short sales for equity-like convertibles before and after the issuance dates. These short positions remain quite persistent over longer period of time, which suggests that arbitrageurs (hedgers) are more likely to be taking those positions than speculative investors. Finally, we find that in a simple convertible arbitrage setting more equity-like conver...
Market Efficiency and Returns from Convertible Bond Hedging and Arbitrage Strategies
The Journal of Alternative Investments, 2009
Note: This exhibit reports the average buy-and-hold returns of buying one convertible bond at the issuance date. The first column indicates the holding period. The second column reports the returns of the pure long CBs portfolio; t-statistics for the returns are shown in Column 3. Column 4 (5) is the number of positive (negative) returns; Column 6 is the total number of observations at the end of X months after the issuance date. Column 7 is the significance level of the t-statistics in Column 3: 1, 2, and 3 denote statistical significance at the 10%, 5%, and 1% levels in a two-tail test, respectively.
Journal of Banking & Finance, 2012
While convertible offerings announced between 1984 and 1999 induce average abnormal stock returns of À1.69%, convertible announcement effects over the period 2000-2008 are more than twice as negative (À4.59%). We hypothesize that this evolution is attributable to a shift in the convertible bond investor base from long-only investors towards convertible arbitrage funds. These funds buy convertibles and short the underlying stocks, causing downward price pressure. Consistent with this hypothesis, we find that the differences in announcement returns between the Traditional Investor period (1984-1999) and the Arbitrage period (2000-September 2008) disappear when controlling for arbitrage-induced short selling associated with a range of hedging strategies. Post-issuance stock returns are also in line with the arbitrage explanation. Average announcement effects of convertibles issued during the Global Financial Crisis are even more negative (À9.12%), due to a combination of short-selling price pressure and issuer, issue, and macroeconomic characteristics associated with these offerings.
Convertible bond arbitrage, liquidity externalities, and stock prices☆
Journal of Financial Economics, 2008
In the context of convertible bond issuance, we examine the impact of arbitrage activity on underlying equity markets. In particular, we use changes in equity short interest following convertible bond issuance to identify convertible bond arbitrage activity and analyze its impact on stock market liquidity and prices for the period 1993 to 2006. There is considerable evidence of arbitrage-induced short selling resulting from issuance. Moreover, we find strong evidence that this activity is systematically related to liquidity improvements in the stock. These results are robust to controlling for the potential endogeneity of arbitrage activity.