Convertible Bond Arbitrage Smart Beta

Peter J. Zeitsch ()
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Peter J. Zeitsch: FactSet Research Systems Inc.

Computational Economics, 2024, vol. 63, issue 1, No 7, 159-192

Abstract: Abstract A transparent, rules based, portfolio construction algorithm is proposed for convertible bond arbitrage. Feature selection is based on a mark-to-market approach where the volatility from the embedded conversion option is implied from the traded credit spread and bond price. The resulting volatility term structure created by linking the bond implied volatility to listed equity volatilities provides a forward looking rich versus cheap feature extraction. Each bond’s relative value translates to its arbitrage potential as a long volatility position. The approach is back tested across all U.S. dollar bonds from 2014. The resulting portfolio returns track and outperform published index benchmarks, thereby producing a smart beta index.

Keywords: Convertible bond arbitrage; Smart beta; Implied volatility term structure; Long vega; Long omicron (search for similar items in EconPapers)
JEL-codes: C32 C53 G11 G12 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s10614-022-10335-6

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