We investigate a potential source of profit to convertible bond arbitrageurs that is new to the literature: anticipatory hedging in advance of convertible bond issues. When the reference stock price in a bond contract is determined after a new issue is announced, anticipatory short selling in the underlying stock can result in “profitable price impact” (PPI). Downward stock price pressure prior to bond pricing creates an abnormally cheap embedded call option. Consistent with PPI, we document issuer stock price declines on bond pricing days that are more concentrated during the last hour of trading and are followed by partial adjustments.

Keywords: convertible bond arbitrage, prehedging

Continue reading here.