Abstract

http://ssrn.com/abstract=885945
 
 

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Risk and Return in Convertible Arbitrage: Evidence from the Convertible Bond Market


Vikas Agarwal


Georgia State University; University of Cologne - Centre for Financial Research (CFR)

William Fung


London Business School

Yee Cheng Loon


affiliation not provided to SSRN

Narayan Y. Naik


London Business School - Institute of Finance and Accounting

December 8, 2010

Journal of Empirical Finance, Forthcoming

Abstract:     
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.

Number of Pages in PDF File: 57

Keywords: Hedge Funds, Convertible Bonds, Convertible Arbitrage, Supply, Risk Factors

JEL Classification: G1''8 G19, G23

Accepted Paper Series





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Date posted: August 15, 2008 ; Last revised: January 15, 2011

Suggested Citation

Agarwal, Vikas and Fung, William and Loon, Yee Cheng and Naik, Narayan Y., Risk and Return in Convertible Arbitrage: Evidence from the Convertible Bond Market (December 8, 2010). Journal of Empirical Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=885945

Contact Information

Vikas Agarwal (Contact Author)
Georgia State University ( email )
35 Broad Street,
Suite 1221
Atlanta, GA 30303-3083
United States
404-413-7326 (Phone)
404-413-7312 (Fax)
HOME PAGE: http://www.gsu.edu/~fncvaa
University of Cologne - Centre for Financial Research (CFR)
Albertus-Magnus Platz
Cologne, 50923
Germany
William (Bill) Fung
London Business School ( email )
Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
Yee Cheng Loon
affiliation not provided to SSRN
Narayan Y. Naik
London Business School - Institute of Finance and Accounting ( email )
Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 724 3317 (Fax)
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