A Liquidity-Based Explanation of Convertible Arbitrage Alphas

Posted: 21 May 2019

See all articles by George E. Batta

George E. Batta

Claremont McKenna College - Robert Day School of Economics and Finance

George Chacko

Santa Clara University

Bala G. Dharan

Harvard Law School; Berkeley Research Group LLC; Rice University

Date Written: May 2010

Abstract

We examine the extent to which excess returns from convertible arbitrage represent positive returns to managers to exploiting pricing inefficiencies versus compensation for exposure to systematic risk factors. Initial empirical tests show that when we exclude liquidity risk 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 we include the effects of liquidity, abnormal returns to convertible bond arbitrage essentially disappear and only remain localized in convertible debt trading closer to the issuance date.

Keywords: convertible debt, valuation, capital markets, puzzle

JEL Classification: G12, G14

Suggested Citation

Batta, George E. and Chacko, George and Dharan, Bala G., A Liquidity-Based Explanation of Convertible Arbitrage Alphas (May 2010). https://doi.org/10.3905/jfi.2010.20.1.028. Available at SSRN: https://ssrn.com/abstract=1016573 or http://dx.doi.org/10.2139/ssrn.1016573

George E. Batta

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth Street
Claremont, CA 91711
United States

George Chacko

Santa Clara University ( email )

500 El Camino Real
Santa Clara, CA 95053
United States

Bala G. Dharan (Contact Author)

Harvard Law School ( email )

1575 Massachusetts
Hauser 406
Cambridge, MA 02138
United States

Berkeley Research Group LLC ( email )

Boston, MA
United States

Rice University ( email )

6100 South Main Street
Houston, TX 77005
United States

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