Convertible Bond Arbitrage and Short Sales: Evidence from the Korean Stock Market

This paper tests if uninformed short sales affect stock prices by examining short selling activities and stock price movements surrounding convertible bond (CB) issuance dates. We assume that short sales associated with CB arbitrage are uninformed since CB arbitrage is a hedge strategy to pursue market-neutral profits. By examining tick -by-tick data containing information on short sales as well as normal trades, we are able to extract a sample of CB arbitrage from all Korean companies which issued CBs during our sample period from January 2004 to June 2006. We find that short sales increase dramatically around the issuance dates of CBs, which clearly demonstrates the existence of CB arbitrages in Korea. Moreover, we find that the foreign investors, more likely hedge funds, are the major players of CB arbitrage. Then, we investigate the impact of uninformed short selling on stock prices. To control the announcement effect of CB issuances we use CB issuers that are not associated with short-selling activities as a control sample. We find that CB arbitrage does not reduce stock prices beyond the level that is normally affected by CB issuance without short selling. This result implies that stock market is efficient enough to absorb unexpectedly large amounts of uninformed short sales.