IDEAS home Printed from https://ideas.repec.org/a/eee/jfinec/v91y2009i2p227-251.html
   My bibliography  Save this article

Convertible bond arbitrage, liquidity externalities, and stock prices

Author

Listed:
  • Choi, Darwin
  • Getmansky, Mila
  • Tookes, Heather

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.

Suggested Citation

  • Choi, Darwin & Getmansky, Mila & Tookes, Heather, 2009. "Convertible bond arbitrage, liquidity externalities, and stock prices," Journal of Financial Economics, Elsevier, vol. 91(2), pages 227-251, February.
    • Handle: RePEc:eee:jfinec:v:91:y:2009:i:2:p:227-251
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0304-405X(08)00187-6
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," The Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
    2. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
    3. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    4. repec:bla:jfinan:v:59:y:2004:i:4:p:1845-1876 is not listed on IDEAS
    5. Stein, Jeremy C., 1992. "Convertible bonds as backdoor equity financing," Journal of Financial Economics, Elsevier, vol. 32(1), pages 3-21, August.
    6. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    7. Arturo Bris & William N. Goetzmann & Ning Zhu, 2007. "Efficiency and the Bear: Short Sales and Markets Around the World," Journal of Finance, American Finance Association, vol. 62(3), pages 1029-1079, June.
    8. Lasse Heje Pedersen & Mark Mitchell & Todd Pulvino, 2007. "Slow Moving Capital," American Economic Review, American Economic Association, vol. 97(2), pages 215-220, May.
    9. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2002. "Order imbalance, liquidity, and market returns," Journal of Financial Economics, Elsevier, vol. 65(1), pages 111-130, July.
    10. Stephen A. Ross, 1976. "Options and Efficiency," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(1), pages 75-89.
    11. repec:bla:jfinan:v:59:y:2004:i:1:p:31-63 is not listed on IDEAS
    12. Basak, Suleyman & Croitoru, Benjamin, 2006. "On the role of arbitrageurs in rational markets," Journal of Financial Economics, Elsevier, vol. 81(1), pages 143-173, July.
    13. Lee, Charles M C & Ready, Mark J, 1991. "Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-746, June.
    14. Tom Arnold & Alexander W. Butler & Timothy Falcon Crack & Yan Zhang, 2005. "The Information Content of Short Interest: A Natural Experiment," The Journal of Business, University of Chicago Press, vol. 78(4), pages 1307-1336, July.
    15. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    16. Jones, Charles M. & Lamont, Owen A., 2002. "Short-sale constraints and stock returns," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 207-239.
    17. Asquith, Paul & Pathak, Parag A. & Ritter, Jay R., 2005. "Short interest, institutional ownership, and stock returns," Journal of Financial Economics, Elsevier, vol. 78(2), pages 243-276, November.
    18. Ingersoll, Jonathan E, Jr, 1977. "An Examination of Corporate Call Policies on Convertible Securities," Journal of Finance, American Finance Association, vol. 32(2), pages 463-478, May.
    19. Dechow, Patricia M. & Hutton, Amy P. & Meulbroek, Lisa & Sloan, Richard G., 2001. "Short-sellers, fundamental analysis, and stock returns," Journal of Financial Economics, Elsevier, vol. 61(1), pages 77-106, July.
    20. Asquith, Paul, 1995. "Convertible Bonds Are Not Called Late," Journal of Finance, American Finance Association, vol. 50(4), pages 1275-1289, September.
    21. Ekkehart Boehmer & Charles M. Jones & Xiaoyan Zhang, 2008. "Which Shorts Are Informed?," Journal of Finance, American Finance Association, vol. 63(2), pages 491-527, April.
    22. repec:bla:jfinan:v:53:y:1998:i:2:p:717-732 is not listed on IDEAS
    23. Owen A. Lamont & Jeremy C. Stein, 2004. "Aggregate Short Interest and Market Valuations," American Economic Review, American Economic Association, vol. 94(2), pages 29-32, May.
    24. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    25. repec:bla:jfinan:v:53:y:1998:i:2:p:431-465 is not listed on IDEAS
    26. Bechmann, Ken L., 2004. "Short sales, price pressure, and the stock price response to convertible bond calls," Journal of Financial Markets, Elsevier, vol. 7(4), pages 427-451, October.
    27. Diamond, Douglas W. & Verrecchia, Robert E., 1987. "Constraints on short-selling and asset price adjustment to private information," Journal of Financial Economics, Elsevier, vol. 18(2), pages 277-311, June.
    28. Biais, Bruno & Hillion, Pierre, 1994. "Insider and Liquidity Trading in Stock and Options Markets," The Review of Financial Studies, Society for Financial Studies, vol. 7(4), pages 743-780.
    29. Detemple, Jerome & Jorion, Philippe, 1990. "Option listing and stock returns : An empirical analysis," Journal of Banking & Finance, Elsevier, vol. 14(4), pages 781-801, October.
    30. Boehme, Rodney D. & Danielsen, Bartley R. & Sorescu, Sorin M., 2006. "Short-Sale Constraints, Differences of Opinion, and Overvaluation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 41(2), pages 455-487, June.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Blau, Benjamin M. & Van Ness, Robert A. & Warr, Richard S., 2012. "Short selling of ADRs and foreign market short-sale constraints," Journal of Banking & Finance, Elsevier, vol. 36(3), pages 886-897.
    2. Tsai, Chia-Fen & Chang, Jung-Hsien & Tsai, Feng-Tse, 2021. "Lottery preferences and retail short selling," Pacific-Basin Finance Journal, Elsevier, vol. 68(C).
    3. Barinov, Alexander & Wu, Juan (Julie), 2014. "High short interest effect and aggregate volatility risk," Journal of Financial Markets, Elsevier, vol. 21(C), pages 98-122.
    4. Lynch, Andrew & Nikolic, Biljana & Yan, Xuemin (Sterling) & Yu, Han, 2014. "Aggregate short selling, commonality, and stock market returns," Journal of Financial Markets, Elsevier, vol. 17(C), pages 199-229.
    5. Stephen L. Lenkey, 2021. "Informed Trading with a Short-Sale Prohibition," Management Science, INFORMS, vol. 67(3), pages 1803-1824, March.
    6. Shyu, Yih-Wen & Chan, Kam C. & Liang, Hsin-Yu, 2018. "Spillovers of price efficiency and informed trading from short sales to margin purchases in absence of uptick rule," Pacific-Basin Finance Journal, Elsevier, vol. 50(C), pages 163-183.
    7. Lin, Chih-Yung & Bui, Dien Giau & Lin, Tse-Chun, 2020. "Do short sellers exploit risky business models of banks? Evidence from two banking crises," Journal of Financial Stability, Elsevier, vol. 46(C).
    8. Hackney, John & Henry, Tyler R. & Koski, Jennifer L., 2020. "Arbitrage vs. informed short selling: Evidence from convertible bond issuers," Journal of Corporate Finance, Elsevier, vol. 65(C).
    9. Takahashi, Hidetomo, 2010. "Short-sale inflow and stock returns: Evidence from Japan," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2403-2412, October.
    10. Bardong, Florian & Bartram, Söhnke M. & Yadav, Pradeep K., 2007. "Are Short-sellers Different?," MPRA Paper 13585, University Library of Munich, Germany, revised 16 Nov 2008.
    11. Blau, Benjamin M. & Tew, Philip L., 2014. "Short sales and class-action lawsuits," Journal of Financial Markets, Elsevier, vol. 20(C), pages 79-100.
    12. Hansson, Fredrik & Rüdow Fors, Erik, 2009. "Get Shorty? - Market Impact of the 2008-09 U.K. Short Selling Ban," Working Papers in Economics 365, University of Gothenburg, Department of Economics.
    13. Blau, Benjamin M. & Smith, Jason M., 2014. "Autocorrelation in daily short-sale volume," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(1), pages 31-41.
    14. Wu, Zhen-Xing & Chen, Tsung-Yu, 2019. "Information asymmetry, market state, and implementation risk," The North American Journal of Economics and Finance, Elsevier, vol. 50(C).
    15. Comerton-Forde, Carole & Jones, Charles M. & Putniņš, Tālis J., 2016. "Shorting at close range: A tale of two types," Journal of Financial Economics, Elsevier, vol. 121(3), pages 546-568.
    16. Wang, Yuchen & Wang, Xiaoming, 2023. "Economic policy uncertainty and information intermediary: The case of short seller," Economic Modelling, Elsevier, vol. 120(C).
    17. Kelley Bergsma & Jitendra Tayal, 2019. "Short Interest and Lottery Stocks," Financial Management, Financial Management Association International, vol. 48(1), pages 187-227, March.
    18. Zhou, Yi, 2022. "Option trading volume by moneyness, firm fundamentals, and expected stock returns," Journal of Financial Markets, Elsevier, vol. 58(C).
    19. Chung, Chune Young & DeVault, Luke & Wang, Kainan, 2019. "Perceived information, short interest, and institutional demand," Journal of Empirical Finance, Elsevier, vol. 54(C), pages 22-38.
    20. Jorida Papakroni, 2018. "The dispersion anomaly and analyst recommendations," Review of Quantitative Finance and Accounting, Springer, vol. 50(3), pages 861-896, April.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jfinec:v:91:y:2009:i:2:p:227-251. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/505576 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.