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Can convertible bond trading predict stock returns? Evidence from China

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  • Chen, Zhiyu
  • Xu, Yun
  • Wang, Yu

Abstract

This paper studies the information content of convertible bond trading in Chinese market. We construct a measure of the convertible bond order imbalance. The analysis shows that the convertible bond order imbalance positively and significantly predicts future stock returns. The results hold in both daily and 30-min frequencies. Our findings are robust by considering the stock price sensitivity of convertible bond. The predictability is of economic significance that the long-short trading strategy based on the convertible bond order imbalance generates an annual return of 17.54%. Moreover, the predictive relations varies with moneyness, conversion premium, limits to arbitrage, level of information asymmetry and maturity. Since stocks are subject to “T + 1” trading rule while convertible bonds are not in Chinese market, convertible bond market provides an alternative venue to gain stock exposures with less trading restrictions. We find that the stock order imbalance exhibits a weaker predictability on stock returns compared to the convertible bond order flows. Our findings suggest that convertible bond market plays an important role in discovering private information of stock prices.

Suggested Citation

  • Chen, Zhiyu & Xu, Yun & Wang, Yu, 2023. "Can convertible bond trading predict stock returns? Evidence from China," Pacific-Basin Finance Journal, Elsevier, vol. 79(C).
    • Handle: RePEc:eee:pacfin:v:79:y:2023:i:c:s0927538x23000926
    DOI: 10.1016/j.pacfin.2023.102026
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    More about this item

    Keywords

    Convertible bond trading; Stock returns; Order imbalance; Predictability;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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