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Financial Markets and Portfolio Management

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08.04.2017

Hedge funds as international liquidity providers: evidence from convertible bond arbitrage in Canada

verfasst von: Evan Gatev, Mingxin Li

Erschienen in: Financial Markets and Portfolio Management | Ausgabe 2/2017

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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.

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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.

See, for example, Chordia et al. (2000), Hasbrouck and Seppi (2001), Kamara et al. (2008), Korajczyk and Sadka (2008), and Bharath et al. (2009).

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)CrossRef

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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)CrossRef

Glosten, L.R., Harris, L.E.: Estimating the components of the bid/ask spread. J. Financ. Econ. 21, 123–142 (1988)CrossRef

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Hasbrouck, J., Seppi, D.J.: Common factors in prices, order flows, and liquidity. J. Financ. Econ. 59, 383–411 (2001)CrossRef

Kamara, A., Lou, X., Sadka, R.: The divergence of liquidity commonality in the cross-section of stock. J. Financ. Econ. 89, 444–466 (2008)CrossRef

Khan, S.: A perspective on convertible arbitrage. J. Wealth Manag. 2002, 59–65 (2002)CrossRef

Korajczyk, R.A., Sadka, R.: Pricing the commonality across alternative measures of liquidity. J. Financ. Econ. 87, 45–72 (2008)CrossRef

Lesmond, D.A., Ogden, J.P., Trzcinka, C.A.: A new estimate of transaction costs. Rev. Financ. Stud. 12(5), 1113–1141 (1999)CrossRef

Loncarski, I., Horst, J., Veld, C.: The rise and demise of the convertible arbitrage strategy. Financ. Anal. J. 65(5), 35–50 (2009)CrossRef

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Tremblay, M.: Portrait of the Canadian hedge fund industry. Bank Canada Financ. Syst. Rev. 2004, 41–44 (2004)

Titel: Hedge funds as international liquidity providers: evidence from convertible bond arbitrage in Canada
verfasst von: Evan Gatev
Mingxin Li
Publikationsdatum: 08.04.2017
Verlag: Springer US
Erschienen in: Financial Markets and Portfolio Management / Ausgabe 2/2017
Print ISSN: 1934-4554
Elektronische ISSN: 2373-8529
DOI: https://doi.org/10.1007/s11408-017-0285-0

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