IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Risk and return in convertible arbitrage: Evidence from the convertible bond market

  • Agarwal, Vikas
  • Fung, William H.
  • Loon, Yee Cheng
  • Naik, Narayan Y.
Registered author(s):

    In this paper, we identify and document the empirical characteristics of the key drivers of convertible arbitrage as a strategy and how they impact the performance of convertible arbitrage hedge funds. We show that the returns of a buy-and-hedge strategy involving taking a long position in convertible bonds ('CBs') while hedging the equity risk alone explains a substantial amount of these funds' return dynamics. In addition, we highlight the importance of non-price variables such as extreme market-wide events and the supply of CBs on performance. Out-of-sample tests provide corroborative evidence on our model's predictions. At a more micro level, larger funds appear to be less dependent on directional exposure to CBs and more active in shorting stocks to hedge their exposure than smaller funds. They are also more vulnerable to supply shocks in the CB market. These findings are consistent with economies of scale that large funds enjoy in accessing the stock loan market. However, the friction involved in adjusting the stock of risk capital managed by a large fund can negatively impact performance when the supply of CBs declines. Taken together, our findings are consistent with convertible arbitrageurs collectively being rewarded for playing an intermediation role of funding CB issuers whilst distributing part of the equity risk of CBs to the equity market.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://econstor.eu/bitstream/10419/43704/1/641902255.pdf
    Download Restriction: no

    Paper provided by University of Cologne, Centre for Financial Research (CFR) in its series CFR Working Papers with number 10-19.

    as
    in new window

    Length:
    Date of creation: 2010
    Date of revision:
    Handle: RePEc:zbw:cfrwps:1019
    Contact details of provider: Postal: 0221 / 470 5607
    Phone: 0221 / 470 5607
    Fax: 0221 / 470 5179
    Web page: http://cfr-cologne.de/english/version06/html/home.php
    Email:


    More information through EDIRC

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. Almazan, Andres & Brown, Keith C. & Carlson, Murray & Chapman, David A., 2004. "Why constrain your mutual fund manager?," Journal of Financial Economics, Elsevier, vol. 73(2), pages 289-321, August.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:zbw:cfrwps:1019. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.