Stock Price Response to Calls of Convertible Bonds: Still a Puzzle

Abstract

The literature has suggested liquidity price pressure as an explanation for the negative abnormal returns surrounding the announcements of conversion-forcing calls of convertible bonds and preferred stock, and of mergers via common stock exchange. We confirm the negative abnormal returns around the conversion-forcing call announcement, and under some specifications we also document a subsequent price recovery. The liquidity hypothesis implies that the price recovery should be inversely related to the initial price decline, and that the abnormal returns during the announcement event and the post announcement event should be related to proxies measuring the stock's liquidity. Our estimates are not consistent with these implications. Finally, we also do not find support for alternative explanations offered in the literature. Hence, we conclude that the reason for the negative abnormal returns around the announcement of a conversion-forcing call is still a puzzle.

Keywords: Convertible bonds, Conversion forcing call, Liquidity pressure, Asymmetric information