Abstract
We examine the impact of Canadian convertible bond issuance on equity market liquidity. Using issuance event dates between April 2002 and March 2011, we analyze the change in short interest and stock liquidity during a 1-year event window. We consider mainstream liquidity measures, including turnover, dollar volume, dollar spread, percentage spread, and the ratio of daily absolute stock return to dollar volume. We find that after convertible bond issuances, there are significant increases in short interest, but minimal overall improvements in liquidity. The change in liquidity is not significantly related to the change in short interest, except for the firms with large change in short interest. Interpreting increased short interest after issuance as a proxy for convertible bond arbitrage activity, the results suggest that there is limited positive liquidity externality of hedge fund activity in Canada.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
For example, when the stock price rises due to an excess demand shock, the delta of the convertible bond increases and the arbitrageurs short additional stock to maintain a delta-neutral position. The short selling eases the price pressure from the buy-order imbalance, improving the liquidity of the stock.
Canadian Hedge Watch, Canadian Hedge Fund Quarterly Industry Report, December 2008.
Tremblay (2004) provides an overview of the breadth of the hedge fund phenomenon in Canada. In addition, according to Lipper Tass Hedge Fund Data, 25.83% of the Canadian hedge funds reported convertibles in their portfolios during our sample period, compared to 15.02% of the US funds.
Loncarski et al. (2009) discuss the hedge ratio and the dynamic hedging process in detail.
As in Choi et al. (2009), we evaluate each potential choice of the control firm by calculating a score as \(\left[ \text {abs}\left( {\frac{{turnover}}{{issuer}\,{turnover}}-1} \right) +\text {abs}\left( {\frac{{market}~{cap}}{{issuer}~{market}~{cap}}-1} \right) +\hbox {abs}\left( {\frac{{book\hbox {-}to\hbox {-}market}}{{issuer}~{book\hbox {-}to\hbox {-}market}}-1} \right) \right] \). Turnover, market capitalization, and book-to-market are average values for the pre-issue period. A lower score means higher similarity to the issuing firm. For each issuer, the selected control firm is the one with the lowest score. The average score for the selected control firms is 0.304.
References
Agarwal, V., Fung, W.H., Loon, Y.C., Naik, N.Y.: Risk and return in convertible arbitrage: evidence from the convertible bond market. J. Empir. Financ. 18, 175–194 (2011)
Amihud, Y.: Illiquidity and stock returns: cross-section and time-series effects. J. Financ. Mark. 5, 31–56 (2002)
Bharath, S.T., Pasquariello, P., Wu, G.: Does asymmetric information drive capital structure decisions? Rev. Financ. Stud. 22(8), 3211–3243 (2009)
Choi, D., Getmansky, M., Tookes, H.: Convertible bond arbitrage, liquidity externalities, and stock prices. J. Financ. Econ. 91, 227–251 (2009)
Chordia, T., Roll, R., Subrahmanyam, A.: Commonality in liquidity. J. Financ. Econ. 56, 3–28 (2000)
Glosten, L.R., Harris, L.E.: Estimating the components of the bid/ask spread. J. Financ. Econ. 21, 123–142 (1988)
Hasbrouck, J.: Measuring the information content of stock trades. J. Financ. 46(1), 179–207 (1991)
Hasbrouck, J., Seppi, D.J.: Common factors in prices, order flows, and liquidity. J. Financ. Econ. 59, 383–411 (2001)
Kamara, A., Lou, X., Sadka, R.: The divergence of liquidity commonality in the cross-section of stock. J. Financ. Econ. 89, 444–466 (2008)
Khan, S.: A perspective on convertible arbitrage. J. Wealth Manag. 2002, 59–65 (2002)
Korajczyk, R.A., Sadka, R.: Pricing the commonality across alternative measures of liquidity. J. Financ. Econ. 87, 45–72 (2008)
Lesmond, D.A., Ogden, J.P., Trzcinka, C.A.: A new estimate of transaction costs. Rev. Financ. Stud. 12(5), 1113–1141 (1999)
Loncarski, I., Horst, J., Veld, C.: The rise and demise of the convertible arbitrage strategy. Financ. Anal. J. 65(5), 35–50 (2009)
Mitchell, M., Pedersen, L., Pulvino, T.: Slow moving capital. Am. Econ. Rev. 97, 215–220 (2007)
Tremblay, M.: Portrait of the Canadian hedge fund industry. Bank Canada Financ. Syst. Rev. 2004, 41–44 (2004)
Acknowledgements
We acknowledge helpful comments from an anonymous referee and the editor, as well as from participants at the 25th Australasian Finance and Banking Conference, the 2013 Auckland Finance Meeting, and the 2014 International Conference on Business and Information.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Gatev, E., Li, M. Hedge funds as international liquidity providers: evidence from convertible bond arbitrage in Canada. Financ Mark Portf Manag 31, 117–136 (2017). https://doi.org/10.1007/s11408-017-0285-0
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11408-017-0285-0