A Liquidity-Based Explanation of Convertible Arbitrage Alphas

The authors examine the extent to which excess returns from convertible arbitrage represent positive returns to managers from exploiting pricing inefficiencies versus compensation for exposure to systematic risk factors. Initial empirical tests show that when liquidity risk is excluded as a factor,...

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Bibliographic Details
Published in:The Journal of fixed income 2010-07, Vol.20 (1), p.28-43
Main Authors: Batta, George, Chacko, George, Dharan, Bala G.
Format: Article
Language:English
Subjects:
Abnormal returns
Arbitrage
Compensation
Convertible bonds
Corporate bonds
Equity
Hedge funds
Hedging
Investment advisors
Investment policy
Liquidity
Prices
Regression analysis
Studies
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Summary:The authors examine the extent to which excess returns from convertible arbitrage represent positive returns to managers from exploiting pricing inefficiencies versus compensation for exposure to systematic risk factors. Initial empirical tests show that when liquidity risk is excluded as a factor, a good portion of abnormal returns to convertible bond strategies appears to be driven both by overpricing of the underlying equity and apparent underpricing of convertible bonds. However, when the effects of liquidity are included, abnormal returns to convertible bond arbitrage essentially disappear and only remain localized in convertible debt trading closer to the issuance date. [PUBLICATION ABSTRACT]
ISSN:1059-8596
2168-8648
DOI:10.3905/jfi.2010.20.1.028