Convertible debt issues and convertible arbitrage – issue characteristics, underpricing and short sales

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. This version: February 7, 2006 JEL codes: G12, G14, G24, G32 Preliminary version – do not cite or quote! 1 Corresponding author: Tilburg University, Department of Finance, P.O.Box 90153, 5000LE Tilburg, The Netherlands, tel.: +31 13 466 36 14, fax.: +31 13 466 28 75, email: [email protected] 2 Tilburg University, Department of Finance, P.O.Box 90153, 5000LE Tilburg, The Netherlands, tel.: +31 13 466 82 11, fax.: +31 13 466 28 75, email: [email protected] 3 Simon Fraser University, 8888 University Drive, Burnaby, B.C. Canada. V5A 1S6, tel.: +1 604 268 67 90, email: [email protected] Chris Veld gratefully recognizes the financial support of the Social Sciences and Humanities Research Council of Canada.