EFFECT OF CONVERTIBLE BOND ANNOUNCEMENT ON THE VOLATILITY OF THE ISSUER: WHAT DOES IT SAY ABOUT THE RATIONALE BEHIND CONVERTIBLE BOND ISSUANCE?

Abstract

This study examines whether the announcement of a convertible bond issuance will affect the volatility of the issuer. I analyzed volatility changes around the announcement of US public convertible bond issues from 2000 to 2010 and found that volatility decreased. However, when I took into account possible self-selection bias by studying the counterfactual volatility changes through the matching of convertible bond issuing firms with their equivalent firms that issued straight bonds, and then with firms that did not issue bonds, I found that the volatility change is generally not significantly different between the matched firms. My results show that convertible bonds are issued primarily to reduce both the direct cost of mis-specifying the returns of the security and the indirect cost of bargaining between the firm and its investors over the true value of firm risk. In other words, convertible bonds are issued to mitigate estimation risk.