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Bridge over ocean
1 September 2009 Financial Analysts Journal Volume 65, Issue 5

The Rise and Demise of the Convertible Arbitrage Strategy

  1. Igor Loncarski
  2. Jenke ter Horst
  3. Chris Veld

This article analyzes convertible arbitrage, one of the most successful hedge
fund strategies. The aim of the strategy is to exploit underpricing of
convertible bonds by taking a long position in a convertible and a short
position in the underlying asset. The authors find that convertible bonds are
underpriced at the issuance dates; at the same time, short sales of underlying
equity increase significantly. Both effects are stronger and more persistent for
equity-like convertibles than for debtlike convertibles. Furthermore, short-sale
pressures negatively affect stock returns around the announcement and issuance
dates of convertibles. All these factors have likely contributed to the shift
toward issuing more debtlike convertibles in recent years, which, in turn, has
substantially lowered the returns from convertible arbitrage.

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