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Convertible Bond Arbitrage Smart Beta

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  • Peter J. Zeitsch

    (FactSet Research Systems Inc.)

Abstract

A transparent, rules based, portfolio construction algorithm is proposed for convertible bond arbitrage. Feature selection is based on a mark-to-market approach where the volatility from the embedded conversion option is implied from the traded credit spread and bond price. The resulting volatility term structure created by linking the bond implied volatility to listed equity volatilities provides a forward looking rich versus cheap feature extraction. Each bond’s relative value translates to its arbitrage potential as a long volatility position. The approach is back tested across all U.S. dollar bonds from 2014. The resulting portfolio returns track and outperform published index benchmarks, thereby producing a smart beta index.

Suggested Citation

  • Peter J. Zeitsch, 2024. "Convertible Bond Arbitrage Smart Beta," Computational Economics, Springer;Society for Computational Economics, vol. 63(1), pages 159-192, January.
    • Handle: RePEc:kap:compec:v:63:y:2024:i:1:d:10.1007_s10614-022-10335-6
    DOI: 10.1007/s10614-022-10335-6
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Convertible bond arbitrage; Smart beta; Implied volatility term structure; Long vega; Long omicron;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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