Convertible Bond Arbitrage, Liquidity Externalities and Stock Prices

58 Pages Posted: 24 May 2006 Last revised: 13 Aug 2010

See all articles by Darwin Choi

Darwin Choi

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Mila Getmansky Sherman

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance

Heather Tookes

Yale University - Yale School of Management; Yale University - International Center for Finance

Date Written: February 27, 2008

Abstract

In the context of convertible bond issuance, we examine the impact of arbitrage activity on underlying equity markets. In particular, we use changes in equity short interest following convertible bond issuance to identify convertible bond arbitrage activity and analyze its impact on stock market liquidity and prices for the period 1993 to 2006. There is considerable evidence of arbitrage-induced short selling resulting from issuance. Moreover, we find strong evidence that this activity is systematically related to liquidity improvements in the stock. These results are robust to controlling for the potential endogeneity of arbitrage activity.

Keywords: Convertible Bond Arbitrage, Liquidity, Spillovers

JEL Classification: G12, G14, G10, G32

Suggested Citation

Choi, Darwin and Getmansky Sherman, Mila and Tookes, Heather, Convertible Bond Arbitrage, Liquidity Externalities and Stock Prices (February 27, 2008). Journal of Financial Economics, Vol. 91, No. 2, pp. 227-251, February 2009; Yale ICF Working Paper No. 08-09. Available at SSRN: https://ssrn.com/abstract=891657

Darwin Choi

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, N.T.
Hong Kong

Mila Getmansky Sherman

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance ( email )

Amherst, MA 01003-4910
United States

Heather Tookes (Contact Author)

Yale University - Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Yale University - International Center for Finance ( email )

Box 208200
New Haven, CT 06520
United States

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