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Abstract:
This article analyzes convertible arbitrage, one of the most successful hedge fund strategies. The aim of the strategy is to exploit underpricing of convertible bonds by taking a long position in a convertible and a short position in the underlying asset. The authors find that convertible bonds are underpriced at the issuance dates; at the same time, short sales of underlying equity increase significantly. Both effects are stronger and more persistent for equity-like convertibles than for debtlike convertibles. Furthermore, short-sale pressures negatively affect stock returns around the announcement and issuance dates of convertibles. All these factors have likely contributed to the shift toward issuing more debtlike convertibles in recent years, which, in turn, has substantially lowered the returns from convertible arbitrage.

Alternative Investments, Hedge Fund Strategies, Equity Investments, Fundamental Analysis and Valuation Models, Research Sources, Portfolio Management, Hedge Fund Strategies

Abstract:
This paper analyzes convertible arbitrage, one of the most successful hedge fund strategies. The aim of the strategy is to exploit underpricing of convertible bonds by taking a long position in a convertible and a short position in the underlying asset. We find that convertible bonds are 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. Furthermore, we find that short sales pressures negatively affect stock returns around announcement and issuance dates of convertibles. In our opinion, this contributed to the shift towards issuing more debt-like convertibles in recent years, which in turn substantially lowered the returns from convertible arbitrage.

convertible arbitrage, underpricing, convertible bonds, hedge funds, excess returns

Abstract:
Recently several warrant pricing studies have become available for different models as well as for different countries. The most important conclusions that can be drawn from reviewing these studies are: (1) it is not necessary to make a correction on option valuation models for the dilution effect; (2) there is no conclusive evidence to replace (dividend corrected) models in which a constant volatility is assumed (Black/Scholes (1973) like models) by more complicated models such as the Jump Diffusion or the CEV model; (3) US and German warrants seem to be priced correctly, while deviations are found for Japanese warrants (underpriced by the market) and Swiss and Dutch warrants (overpriced by the market).

Abstract:
We study the pricing of reverse convertible bonds. These are bonds that carry high coupon payments. In exchange, the issuer has an option at the maturity date to either redeem the bonds in cash, or to deliver a pre-specified number of shares. We find that Dutch plain vanilla and knock-in reverse convertible bonds are, on average, overpriced by almost 6%. This overpricing is confirmed in a model-free analysis with respect to option and bond pricing models. We find that rational factors explain 23% of the documented overpricing. In addition, we find that the combination of financial marketing, framing, and the representativeness bias further increases our ability to explain the documented overpricing to more than 35%.

reverse convertible bonds, reverse exchangeable securities, structured products

Abstract:
This paper empirically compares three convertible bond valuation models. We use an innovative approach where all model parameters are estimated by the Marquardt (1963) algorithm using a subsample of convertible bond prices. The model parameters are then used for out-of-sample forecasts of convertible bond prices. The mean absolute deviation is 1.86% for the Ayache-Forsyth-Vetzal (2003) model, 1.94% for the Tsiveriotis-Fernandes (1998) model, and 3.73% for the Brennan-Schwartz (1980) model. For this and other measures of fit, the Ayache-Forsyth-Vetzal (2003) and Tsiveriotis-Fernandes (1998) models outperform the Brennan-Schwartz (1980) model.

convertible bonds, credit risk, Ayache-Forsyth-Vetzal model, Brennan-Schwartz model, Tsiveriotis-Fernandes model

Abstract:
The literature on the motives for the issuance of convertible debt is reviewed. This literature shows a large discrepancy between theory and practice. Surveys show that managers base their motives for the use of convertible debt on factors that are irrational according to the theoretical literature. This theoretical literature in turn offers a number of rational motives. These motives are based on the resolution of the problems of informational asymmetry and agency costs, on tax motivations and managerial entrenchment arguments. Most of the rational motives have been investigated in the cross-sectional studies, which offer general support to at least some of them. However, the survey studies find very little to no support for the rational motives. This might be due to either the sensitivity of the surveys to the question contents, to the use of weak proxies in the cross-sectional studies, or a combination of these. In our view, future research in this field should aim for an approach that combines the use of survey data and cross-sectional analysis. We believe that such an approach may bridge the gap between theory and practice.

convertible debt, security issuance, theory, surveys, empirical evidence, review

Abstract:
We empirically investigate dividend and share repurchase policies of Canadian firms. We have sent a questionnaire to the 500 largest non-financial Canadian companies listed on the Toronto Stock Exchange, of which 191 usable responses were returned. These data are used to measure firm characteristics. We use several logit regression analyses to test the structure and determinants of the dividend and share repurchase choice. Our results are consistent with a structure in which the company first decides whether it wants to pay out cash to its shareholders or not. In the second stage the firm decides on the form of the payout: dividends, share repurchases or both. Payout is determined by free cash flow. The choice for dividends and repurchases depends on behavioral and tax preferences. Furthermore, the payout is less likely to be dividends if the company has executive stock option plans. Finally, we find evidence for the Brennan and Thakor (1990) model. According to this model the existence of asymmetric information amongst outsiders is associated with a preference for dividend payments over share repurchases.

dividends, share repurchases, strategic financial decisions, payout decisions, nested logit models

Abstract:
In this paper we study value strategies for four European countries (France, Germany, the Netherlands and the United Kingdom). We find an outperformance for all four value variables
which are investigated: the earnings-to-price (E/P) ratio, the cash-flow-to-price (CF/P) ratio, the book-to-market (B/M) ratio and the dividend yield. This outperformance is especially
remarkable for the CF/P ratio, which amounts to 20.8% between the top and bottom quintiles in an univariate model. In a regression analysis, in which all four value variables as well as a correction for the size effect are taken into account, we find a difference of 11.8% for the CF/P ratio. We demonstrate that this result can not be explained by risk differences alone. Our findings confirm the outperformance of value strategies as found earlier by Chan, Hamao and Lakonishok (1991) and Lakonishok, schleifer and Vishny (1994) for Japan and the United States respectively.

Abstract:
We study incremental capital structure decisions of Dutch companies. From 1977 to 1996 these companies have made 110 issues of public and private seasoned equity and 137 public issues of straight debt. Managers of Dutch companies are entrenched. For this reason a discrepancy exists between managerial decisions and shareholder reactions. Confirming Zwiebel (1996) we find that Dutch managers avoid the disciplining role of debt allowing them to overinvest. However, the market reactions show that this overinvestment behavior is recognized. We do not find a confirmation of the adverse selection model of Myers and Majluf (1984). This is probably due to the entrenchment of managers and the prevalence of rights issues.

Abstract:
We study incremental capital structure decisions of Dutch companies. From 1977 to 1996 these companies have made 110 issues of public and private seasoned equity and 137 public issues of straight debt. Managers of Dutch companies are entrenched. For this reason a discrepancy exists between managerial decisions and shareholder reactions. Confirming Zwiebel (1996) we find that Dutch managers avoid the disciplining role of debt allowing them to overinvest. However, the market reactions show that this overinvestment behavior is recognized. We do not find a confirmation of the adverse selection model of Myers and Majluf (1984). This is probably due to the entrenchment of managers and the prevalence of rights issues.

Abstract:
This paper reviews the literature on the factors that influence the wealth effects associated with the announcements of corporate spin-offs (also known as demergers). Meta-analysis is used to summarize the findings of 26 event studies on spin-off announcements. A significantly positive average abnormal return of 3.02% is found during the event window. Returns are higher for larger spin-offs, for divestments that are tax or regulatory friendly and for spin-offs that lead to an improvement of industrial focus. It is also found that spin-offs that are later completed are associated with lower abnormal returns than non-completed spin-offs. The second part of the paper overviews studies on the long-run stock price performance of spin-offs. Even though early studies find a long-run superior performance, this effect is no longer found in later studies that use more refined statistical tests.

Abstract:
This paper reviews the literature on the factors that influence the wealth effects associated with the announcements of corporate spin-offs. We use meta-analysis to summarize the findings of 26 event studies on spin-off announcements. We find a significantly positive average abnormal return of 3.02% during the event window. Returns are higher for larger spin-offs, for divestments that are tax or regulatory friendly and for spin-offs that lead to the divestiture of a non-related division. We also find that spin-offs that are later completed are associated with lower abnormal returns than non-completed spin-offs. In the second part of the paper we overview studies on the long-run stock price performance of spin-offs. Even though early studies find a long-run superior performance, this effect is no longer found in later studies that use more refined statistical tests.

spin-offs, demergers, value creation, event study, meta-analysis, long-run excess returns, industrial focus

Abstract:
The question of why individual investors want dividends is investigated by submitting a questionnaire to a Dutch investor panel. The respondents indicate that they want dividends partly because the cost of cashing in dividends is lower than the cost of selling shares. Their answers provide strong confirmation for the signaling theories of Bhattacharya (1979) and Miller and Rock (1985). They are inconsistent with the uncertainty resolution theory of Gordon (1961, 1962) and the agency theories of Jensen (1986) and Easterbrook (1984). The behavioral finance theory of Shefrin and Statman (1984) is not confirmed for cash dividends but is confirmed for stock dividends. Finally, our results indicate that individual investors do not tend to consume a large part of their dividends. This raises some doubt as to whether a reduction or elimination of dividend taxes will stimulate the economy.

dividends, individual investors, survey

Abstract:
We study wealth effects for a sample of 156 spin-offs from 15 different European countries that were announced between January 1987 and September 2000. The cumulative average abnormal return over the three-day event window is 2.62%. This number increases to 2.66% for the subsequently completed spin-offs. The cumulative average abnormal return is 3.57% for completed spin-offs by companies that increase their industrial focus and only 0.76% for non-focus increasing companies. The difference between these two sub-samples is significantly different from zero. These results are in line with previous studies for the United States. The long-run returns in excess of matching firms are mostly insignificant both for focus-increasing and non-focus increasing parents, subsidiaries and pro-forma combined firms. This result suggests that, unlike U.S. spin-offs, European spin-offs are not associated with long-run outperformance.

Abstract:
We study the announcement effects and their determinants of convertible debt issues in the Canadian market in order to identify issuer motives. The average wealth effect for the three-day event window around the announcement of convertible bonds between 1991 and 2004 is a significantly negative -2.7%. When the issues are classified into equity- and debt-like, we find that the wealth effects are significantly more negative for the equity-like convertible bond issuers. Equity-like convertibles are significantly negatively affected by agency costs of equity. However, agency costs of debt do not have a significant effect on equity-like convertibles and agency costs of equity do not have a significant effect on debt-like convertibles. These findings suggest that convertibles are used to mitigate different aspects of informational asymmetries. These findings are in line with motives proposed by Stein (1992). Moreover, we find that convertible debt offers announced by income trusts, which have become a special feature of the Canadian market, experience significantly less negative wealth effects than similar offers announced by other issuers. This result can be explained by a more debt-like convertible design and/or very low agency costs of equity in case of income trusts.

event study, convertible bonds, wealth effects, agency costs, income trusts

Abstract:
We investigate the efficiency of the market for 5 year call options which are traded on the European Options Exchange in Amsterdam. We study both delta, delta-vega, and delta-gamma neutral arbitrage portfolios. We do not detect any serious inefficiencies in the market for Dutch long term call options. This result is in line with previous studies on different kinds of call options and warrants. The results for the delta-vega and delta-gamma neutral arbitrage strategies differ from the results of the simple delta-neutral strategies in two ways: they lead to positive results more often, but the variance of these results is also larger.

Abstract:
Since 1998, large investment banks have flooded the European capital markets with issues of call warrants. This has led to a unique situation in the Netherlands, where now call warrants, traded on the stock exchange, and long-term call options, traded on the options exchange, exist. Both entitle their holders to buy shares of common stock. We use the longterm call options in order to price the call warrants. Using the model of Black and Scholes (1973), the Square Root model version of the Constant Elasticity of Variance model of Cox and Ross (1976), and the Binomial model of Cox et al. (1979) we find that the call warrants are strongly overvalued during the first five trading days. The average overvaluation is between 25 and 30 percent for all three models. Only a small part of this overvaluation can be explained by rational arguments such as transaction costs. We conclude that the overvaluation can be attributed to a behavioral preference of private investors for call warrants.

long term options, call options, call warrants, Black-Scholes option pricing model, behavioral finance

Abstract:
Risk perceptions of individual investors are studied by asking experimental questions to 2,226 members of a consumer panel. Their responses are analyzed in order to find which risk measures they implicitly use. We find that most investors implicitly use more than one risk measure. For those investors who systematically perceive risk according to the same risk measure, semi-variance of returns is most popular. Semi-variance is similar to variance, but only negative deviations fro the mean or another benchmark are taken into account. Stock investors implicitly choose for semi-variance as a risk measure, while bond investors favor probability of loss. Investors state that they consider the original investment to be the most important benchmark, followed by the risk-free rate of return, and the market return. However, their choices in the experimental questionnaire study reveal that the market return is the most important benchmark.

individual investors, risk profile, variance, downside risk measures, shortfall, semi-variance, experimental questionnaire study

Abstract:
Spin-off announcements affect bondholders in two possible ways. Bondholders may profit from the increase in the total firm value that is caused by a spin-off. On the other hand, they may also suffer from a wealth transfer from bondholders to shareholders, because they loose part of the coinsurance effect that occurs in diversified firms. This problem is studied by analyzing daily stock and bond abnormal returns around spin-off announcements. Over a three-day event window, we find statistically significant abnormal returns of 3.07% for shareholders and 0.11% for bondholders. The latter result contrasts a finding by Maxwell and Rao (2003) who use monthly bond returns. Both stock and bond abnormal returns are higher for firms with higher pre-spin-off leverage and lower interest and dividend payouts. Focus-increasing spin-offs are associated with higher abnormal returns for shareholders, but not for bondholders. Overall, we find that the firm value increase compensates for the wealth transfer effect and that bondholders' wealth is not reduced as a result of spin-off.

Spin-offs, divestitures, wealth transfer

Abstract:
In November 2002, Stanley Gibbons, a large British stamp dealer, introduced the SG 100, an index for stamp investments. This index is used to study whether there are diversification benefits for British and American stock investors to invest in stamps. The Capital Asset Pricing Model regression of the mean monthly stamp index excess returns on the excess returns of stock indexes yields positive alphas for both British and American investors. This means that adding stamps to stock portfolios can improve the investment performance of both groups of investors.

alternative investments, stamps, diversification benefits

Abstract:
Put-call parity is used to study the early exercise premium for currency options traded on the Philadelphia Stock Exchange. Using 564 pairs of call and put options evidence is provided that the early exercise premia is on average 5.71% for put options and 6.88% for call options. The premiums for both call and put options are strongly related to time to maturity and the interest rate differential. These results are important when using a European option pricing model for the valuation of American options.

Put-call parity, currency options, early exercise premium, Black-Scholes option pricing model

Abstract:
We study determinants of public financing choice in relation to three security issuance theories: market timing (e.g., Stein, 1996), pecking order (Donaldson, 1961; Myers and Majluf, 1984), and investor-manager agreement (Dittmar and Thakor, 2007), in a sample of debt and equity issues and share repurchases of Canadian firms between 1998 and 2004. With respect to market timing, using the market-to-book equity ratio to measure valuation, we find that equity issuers are more overvalued than debt issuers and equity repurchasers. Recognizing that the market-to-book ratio may also indicate growth prospects, we further study the announcement and post-announcement (3-month) return performance. We find that short-run announcement period returns do not lead to a robust conclusion regarding the relation between market performance and market-to-book. However, the long-run returns are consistently lower for issuers with high market-to-book ratios, and this long-run return difference is an order of magnitude more significant than the difference in announcement period returns. These findings give support to the market timing theory of security issuance. With respect to pecking order, we find that a higher degree of financial constraints increases the probability of issuing equity compared to debt, but only after controlling for firm size. This result indicates that large firms use debt financing more than small firms do; after controlling for this size effect, firms' choice between debt and equity issuance is consistent with the pecking order theory that less constrained firms prefer debt to equity. Our finding indicates that pecking order and market timing theories are not mutually exclusive and can affect issuance decisions simultaneously. Lastly, we find no evidence that companies issue equity when agreement between outside investors and managers is high. On the contrary, we find that the probability of issuing equity increases in the level of "disagreement", as proxied by the dispersion of analyst earnings forecasts, and is unrelated to "agreement", as proxied by the discrepancy between actual and forecast earnings. Since these proxies are also measures of information asymmetry, our results are inconsistent with findings based on US studies that firms with high levels of information asymmetry tend to issue debt to avoid high informational costs. Therefore, the investor-manager agreement theory of Dittmar and Thakor (2007), and more broadly, the information asymmetry theory about debt-equity choice, are not robust to different capital markets.

security issuance choice, market timing, pecking order theory, investor-manager agreement

Abstract:
This paper examines the market memory effect in convertible bond markets. More specifically, we look at the pricing of convertible bonds issued after the original issuer redeemed previous issues without giving an opportunity for investors to benefit from bond value appreciation. We find evidence that the market underprices new convertible bond issues of firms that call their bonds early. We also find that the equity-like bonds of early calling firms are more underpriced than debt-like bonds of the same firms.

convertible bonds, optimal call policy, market memory

Abstract:
Since 1998, large investment banks have become active as issuers of options, generally referred to as call warrants or bank-issued options. This has led to an interesting situation in the Netherlands, where simultaneously call warrants are traded on the stock exchange, and long-term call options are traded on the options exchange. Both entitle their holders to buy shares of common stock. We start with a direct comparison between call warrants and call options, written on the same stock and with the same exercise price, but where the call option has a longer time to maturity. In 13 out of 16 cases we find that the call warrants are priced higher, which is a clear violation of basic option pricing rules. In the second part of the analysis we use option pricing models to compare the pricing of call warrants and call options. If implied standard deviations from options are used to price the call warrants, we find that the call warrants are strongly overpriced during the first five trading days. The average overpricing is between 25 and 30%. Only a small part of the overpricing can be explained by rational arguments such as transaction costs. We suggest that the overvaluation can be explained by a combination of an active financial marketing by the banks and the framing effect.

Abstract:
In this paper we use the put-call parity to calculate the premium for early exercise of put options on the DAX index. Because this is a performance index, it is not necessary to separate this premium from the early exercise premium of a call option. We find the early exercise premium of a put option to be positively correlated with the moneyness and the standard deviation of the returns on the index.

Abstract:
This study investigates the announcement effects of offerings of convertible bond loans and warrant-bond loans using data for the Dutch market. Using standard event study methodology it is found that on average stock prices show a positive but insignificant abnormal return for the announcement of a convertible bond loan and a significant positive abnormal return for the announcement of a warrant- bond loan. These findings contrast with studies for the United States which generally find significant negative abnormal returns for convertible bond loans and negative but no significant abnormal returns for warrant-bond loans. This can be explained by the fact that Dutch companies generally package these announcements with other (good) firm specific news. Using regression analysis, in which the main characteristics of the underlying issue are taken into account, it is found that shareholders react more positively to the announcement of warrant-bond loans than to the announcement of convertible bond loans.

Abstract:
Existing research on the hedging effectiveness of currency futures assumes that futures positions are continuously adjusted. This is an unrealistic assumption in practice. In this paper we study the hedging effectiveness for futures positions which are not adjusted during the hedge period. For this purpose an out-of-sample approach is used. Three models are used to determine hedge ratios and hedging effectiveness. These are the minimum-variance model of Ederington (1979), the target return model of Fishburn (1977), which is a model in which the disutility of a loss is minimized, and the Sharpe-ratio model of Howard and D'Antonio (1984, 1987). For the minimum-variance model and the target return model it is found that the naively hedged positions yield a higher effectiveness than the unadjusted model-based hedged positions. For the Sharpe-ratio model it is found that both naively and model-based hedged positions lead to a lower hedging effectiveness than unhedged positions.

Abstract:
This paper investigates the pricing of Dutch index warrants. It is found that when using the historical standard deviation as an estimate for the volatility, the Black and Scholes model underprices all put warrants and call warrants on the FT-SE 100 and the CAC 40, while it overprices the call warrants on the DAX. When the implied volatility of the previous day is used the model prices the index warrants fairly well. When the historical standard deviation is used the mispricing of the call and the put warrants depends in a strong way on the mispricing of the previous trading day, and on the moneyness (in a nonlinear way), the volatility, and the dividend yield. When the implied standard deviation of the previous trading day is used the mispricing of the call warrants is only related to the moneyness and to the estimated volatility, while the mispricing of put index warrants depends in a strong way on the moneyness, the volatility, the dividend yield, and the remaining time to maturity.

Abstract:
This paper investigates the pricing of Dutch index warrants. It is found that when using the historical standard deviation as an estimate for the volatility, the Black and Scholes model underprices all put warrants and call warrants on the FT-SE 100 and the CAC 40, while it overprices the warrants on the DAX. When the implied volatility of the previous day is used the model prices the index warrants fairly well. When the historical standard deviation is used the mispricing of the call and put warrants depends in a strong way on the mispricing of the previous trading day, and on the moneyness (in a nonlinear way), the volatility and the dividend yield. When the implied standard deviation of the previous trading day is used the mispricing of the call warrants is only related to the moneyness and to the estimated volatility, while the mispricing of put index warrants depends in a strong way on the moneyness, the volatility, the dividend yield and the remaining time to maturity.