Convertible Bond Arbitrageurs as Suppliers of Capital

Abstract

This paper examines the potential impact of capital supply on security issuance. We focus on the role of convertible bond arbitrageurs as suppliers of capital to issuers of convertible bonds. We estimate a simultaneous equations model of demand and supply of convertible bond capital, linking the time series of aggregate convertible bond issuance to measures of capital supply: convertible bond arbitrage hedge fund flows, returns, and a proxy for arbitrageurs' use of leverage. We find that issuance is positively and significantly related to increases in all three supply measures. To provide further interpretation, we conduct a second test. We use the ban on short selling in September and October 2008 as a natural experiment to examine the impact of an exogenous shock to the supply of capital from convertible bond arbitrageurs. We find a significant decline in issuance during the ban. Results from both empirical approaches provide evidence that the supply of capital from convertible bond arbitrageurs impacts issuance.

Keywords: capital structure, supply of capital, convertible bond arbitrage, hedge funds, short selling, crisis of 2008

JEL Classification: G32, G23