The Rise and Demise of the Convertible Arbitrage Strategy

25 Pages Posted: 23 Feb 2007 Last revised: 12 Feb 2009

See all articles by Igor Loncarski

Igor Loncarski

University of Ljubljana - Faculty of Economics

Jenke ter Horst

TIAS School for Business and Society

Chris Veld

Monash University

Multiple version iconThere are 2 versions of this paper

Date Written: January 23, 2009

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.

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

JEL Classification: G12, G14, G24, G32

Suggested Citation

Lončarski, Igor and ter Horst, Jenke R. and Veld, Chris, The Rise and Demise of the Convertible Arbitrage Strategy (January 23, 2009). Available at SSRN: https://ssrn.com/abstract=929951 or http://dx.doi.org/10.2139/ssrn.929951

Igor Lončarski (Contact Author)

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, SI-1000
Slovenia
+386 5892 628 (Phone)
+386 5892 698 (Fax)

Jenke R. Ter Horst

TIAS School for Business and Society ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Chris Veld

Monash University ( email )

Building 11E
Clayton, Victoria 3800
Australia

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