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Convertible Debt Arbitrage Crashes Revisited

Published online by Cambridge University Press:  27 April 2023

Craig Lewis ,
Ben Munyan  and
Patrick Verwijmeren
Craig Lewis*
Affiliation:
Vanderbilt University Owen Graduate School of Management
Ben Munyan
Affiliation:
Federal Reserve Bank of Dallas [email protected]
Patrick Verwijmeren
Affiliation:
Erasmus School of Economics and University of Melbourne [email protected]
*
[email protected] (corresponding author)
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Abstract

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This article examines the severity of the 2008 arbitrage crash in the convertible bond market by estimating how expensive it would have been to liquidate portfolio securities immediately. We consider whether funds actually demanded immediate liquidity or were able to delay trades. Our results indicate that the cost of immediacy was high, but that convertible bond sellers could largely avoid selling at fire sale prices. These results can be explained by dealers recognizing when trades are liquidity-motivated rather than information-based and by a shift to riskless principal trading, allowing dealers to avoid taking bonds into inventory.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 4 , June 2024 , pp. 1926 - 1962
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

The authors thank Hendrik Bessembinder (the editor), Jay Ritter, Christoph Schenzler, Norman Schürhoff (the referee), Li Ting Chiu, and seminar participants at Bocconi University, the Office of Financial Research, the University of Washington, and Erasmus University Rotterdam for helpful comments and discussion.

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