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

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  • Duarte, Jefferson
  • Longstaff, Francis A.
  • Yu, Fan

Abstract

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. We show that the risk-adjusted excess returns from these strategies are related to capital flows into fixed income arbitrage hedge funds. In contrast with other hedge fund strategies, we find that many of the fixed income arbitrage strategies produce positively skewed returns. These results suggest that there may be more economic substance to fixed income arbitrage than simply “picking up nickels in front of a steamroller.”

Suggested Citation

  • Duarte, Jefferson & Longstaff, Francis A. & Yu, Fan, 2005. "Risk and Return in Fixed Income Arbitage: Nickels in Front of a Steamroller?," University of California at Los Angeles, Anderson Graduate School of Management qt6zx6m7fp, Anderson Graduate School of Management, UCLA.
    • Handle: RePEc:cdl:anderf:qt6zx6m7fp
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    2. Kalimipalli, Madhu & Nayak, Subhankar & Perez, M. Fabricio, 2013. "Dynamic effects of idiosyncratic volatility and liquidity on corporate bond spreads," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2969-2990.
    3. Hann-Shing Ju & Ren-Raw Chen & Shih-Kuo Yeh & Tung-Hsiao Yang, 2015. "Evaluation of conducting capital structure arbitrage using the multi-period extended Geske–Johnson model," Review of Quantitative Finance and Accounting, Springer, vol. 44(1), pages 89-111, January.
    4. Kessler, Stephan & Scherer, Bernd, 2009. "Varying risk premia in international bond markets," Journal of Banking & Finance, Elsevier, vol. 33(8), pages 1361-1375, August.
    5. Kalimipalli, Madhu & Nayak, Subhankar, 2012. "Idiosyncratic volatility vs. liquidity? Evidence from the US corporate bond market," Journal of Financial Intermediation, Elsevier, vol. 21(2), pages 217-242.
    6. Shackelford, Douglas A. & Shaviro, Daniel N. & Slemrod, Joel, 2010. "Taxation and the Financial Sector," National Tax Journal, National Tax Association;National Tax Journal, vol. 63(4), pages 781-806, December.

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