Convertible Bond Arbitrage, Happy Meals, and Insider Trading

Abstract

Consistent with hedge funds trading on privileged information during the wall-crossing period, we document negative abnormal returns and abnormally high short selling in the trading days just prior to the private placements of U.S. convertible bonds, no pre-placement negative abnormal returns and less pre-placement abnormal short selling volume for convert issuers who engage in related stock buybacks, and more pre-placement short selling for convert issues subject to more intense post-issue short selling. Alternative explanations for our results are rejected because pre-placement anomalies are related to specific terms of the converts and related buybacks. Short interest disclosure needs to be more transparent and Regulation Fair Disclosure better enforced.

Keywords: Convertible bond arbitrage, hedge funds, insider trading, short selling

JEL Classification: D82, G2, G38