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

Finance

BNP Paribas Hedge Fund Centre Working Paper Series

Agarwal V; Naik N Y; et al.

Narayan Naik

2006

This paper analyzes the risk-return characteristics of convertible arbitrage (CA) strategy. Using data on US and Japanese convertible bonds (CBs), we create three basic strategies commonly employed by arbitrageurs in the CB market. We compute returns on these strategies and show that they explain a significant proportion of the variation in returns of CA hedge funds. We provide empirical results showing how CA hedge funds respond to extreme market events such as LTCM crisis. Finally, we demonstrate that the risk-adjusted returns of CA hedge funds are affected by mismatches between supply of and demand for CBs. After adjusting for these mismatches, empirical evidence reveals no abnormal returns accruing to CA hedge funds. Our findings are consistent with arbitrageurs acting as liquidity providers to the CB markets.

This paper has been revised and replaced by HF-0??

Hedge Fund Centre

HF-020

BNP Paribas Hedge Fund Centre Working Paper Series

No