Risk and Return in Fixed-Income Arbitrage: Nickels in Front of a Steamroller?

We conduct an analysis of the risk and return characteristics of a number of widely used fixed-income arbitrage strategies. We find that the strategies requiring more "intellectual capital" to implement tend to produce significant alphas after controlling for bond and equity market risk fa...

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Bibliographic Details
Published in:The Review of financial studies 2007-05, Vol.20 (3), p.769-811
Main Authors: Duarte, Jefferson, Longstaff, Francis A., Yu, Fan
Format: Article
Language:English
Subjects:
Arbitrage
Bond markets
Capital structure
Certificates of deposit
Equity
Financial instruments
Hedge funds
Intellectual capital
Investment risk
Losses
Mortgage loans
Swap spread
Treasury bonds
Volatility
Yield curves
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Summary:We conduct an analysis of the risk and return characteristics of a number of widely used fixed-income arbitrage strategies. We find that the strategies requiring more "intellectual capital" to implement tend to produce significant alphas after controlling for bond and equity market risk factors. These positive alphas remain significant even after taking into account typical hedge fund fees. In contrast with other hedge fund strategies, many of the fixed-income arbitrage strategies produce positively skewed returns. These results suggest that there may be more economic substance to fixedincome arbitrage than simply "picking up nickels in front of a steamroller."
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhl026