IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Evidence on the Limits of Arbitrage: Short Sales, Price Pressure, and the Stock Price Response to Convertible Bond Calls

Listed author(s):
  • Bechmann, Ken L.

    (Department of Finance, Copenhagen Business School)

Registered author(s):

    The announcement of a convertible bond call is associated with an average contem- poraneous abnormal stock price decline of 1.75% and an ensuing price recovery in the conversion period. A price fall and the subsequent recovery suggest price pressure as the explanation for the announcement e ect. In a perfect capital market the option to convert will not be exercised early. The increase in the number of shares outstanding will then occur at the end of the con- version period and not at the earlier announcement date. This study's focus is on the increase in supply that occurs at the announcement day due to short selling of the calling company's stock. Two groups actively engage in short selling in anticipation of, and response to, a convertible bond call. Arbitrageurs buy the convertible and short stock against the equity component of their bond position. Underwriters hedge their exposure by shorting stock. This study examines the relation between short selling around a call announcement, the number of new shares to be issued upon conversion, the predictability ofthe call, the price reaction to the call announcement, and the subsequent price recovery. We conclude that short selling induced price pressure explains at least part of the stock price response to calls. The study's results suggest that an understanding of the stock price response to convertible bond calls actually requires an understanding of optimal compensation schemes, risk aversion, and agency problems within the rms that short sell in response to calls. When short selling by arbitrageurs and underwriters tem- porarily depresses prices by 1.75%, what are the Shleifer and Vishny (1997) \limits of arbitrage" that give rise to the bene t of hedging by selling such underpriced stock?

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL:
    Download Restriction: no

    Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number 2001-7.

    in new window

    Length: 50 pages
    Date of creation: 09 Oct 2001
    Handle: RePEc:hhs:cbsfin:2001_007
    Contact details of provider: Postal:
    Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark

    Phone: +45 3815 3815
    Web page:

    More information through EDIRC

    No references listed on IDEAS
    You can help add them by filling out this form.

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:hhs:cbsfin:2001_007. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lars Nondal)

    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 references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.