An Examination of Convertible Bond Arbitrage: Trading Strategies

Abstract

This paper aims to examine various convertible arbitrage trading strategies whilst having an extra focus on the traditional convertible arbitrage trading strategy. Most of these trading strategies aim to exploit the apparent underpricing that is commonly reported for convertible bonds. This is usually done 3 through taking a hedging position in the underlying stock, and the strategies are then thoroughly evaluated from multiple angles. The results found in this paper suggest that the hedging strategies provide better risk adjusted returns than going long either the pure convertible or the underlying stock. Furthermore, the strategies analyzed are found to provide higher Sharpe ratios than the S&P 500 across the sample period used. Interestingly, however, when the holding period of the strategy is set more in line with that used by practitioners of the convertible arbitrage strategy, the Sharpe ratios fall noticeably becoming closer to the that of the S&P 500. Thereby suggesting that convertible arbitrageurs can benefit from reexamining how they design their strategy.