Market Efficiency and Returns from Convertible Bond Hedging and Arbitrage Strategies

Abstract

in this article, we examine a large set of trading strategies related to CBs to test for abnormal returns for several trading strategies, including various approaches for testing other forms of fixed income arbitrage. As a first step, we examine the naked long position of CBs/underlying stocks and the sensitivity of convertible returns to various risk factors. Second, we test for efficiency based on deviations from the 'law of one price' using relative returns of different combinations of long CBs with short positions in underlying stocks, which include equal money positions, delta-neutral positions, and bearish/bullish gamma positions. We also study the robustness of the various trading strategies to transaction costs, leverage effects, and alternative parameter inputs.

Keywords: convertible arbitrage, market efficiency, law of one price