Liquidity Frictions in Convertible Bond Arbitrage: Evidence from the US

Abstract

We study Over-The-Counter (OTC) market frictions in the convertible bond arbitrage strategy. using noise and intermediary risk factors, in the US. We analyze two hedge fund indices, the convertible arbitrage indices of Credit Suisse (CSFB) and Hedge Fund Research (HFRI), alongside a simulated convertible arbitrage portfolio based on historical data. Using multiple regression models, we find that the strategy has negative exposure towards noise risk and positive exposure towards intermediary risk. Our results are robust to including standard risk factors. We conclude that noise and intermediary risk factors explain part of convertible arbitrage returns in the US.