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In- and out-of-the-money convertible bond calls: Signaling or price pressure?

Listed author(s):
  • Bechmann, Ken L.
  • Lunde, Asger
  • Zebedee, Allan A.
Registered author(s):

    Convertible bond calls typically cause significant reactions in equity prices. The empirical research largely finds negative and positive announcement effects for the in-the-money and the out-of-the-money calls respectively. However, this research has difficulty distinguishing between the two main theoretical explanations: the signaling effect and the price pressure effect. In this paper, we differentiate between these two effects by using a unique data set of the in- and the out-of-the-money calls in the United States during the period of 1993 to 2007. We find that the announcement effect for the in-the-money call is predominantly explained by the subsequent order imbalances; and the stock market's reaction is spread over an entire trading day, which is consistent with the price pressure effect. In contrast, the announcement effect for the out-of-the-money call is driven by the size of the called convertible bond; and the stock market's reaction is almost immediate, which is consistent with the signaling effect.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0929119913001077
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    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 24 (2014)
    Issue (Month): C ()
    Pages: 135-148

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    Handle: RePEc:eee:corfin:v:24:y:2014:i:c:p:135-148
    DOI: 10.1016/j.jcorpfin.2013.11.002
    Contact details of provider: Web page: http://www.elsevier.com/locate/jcorpfin

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