Convertible Bond Arbitrage Using the Volatility Surface

  • The results indicate that there is a mispricing, but it is not an underpricing as widely reported but rather an overpricing.
  • The profitability of the strategy was shown to largely depend on avoiding rich bonds and delta hedging those bonds with a well-defined, or consistent, implied volatility term structure.
  • The common contention that convertible arbitrage is a gamma trading strategy was shown to be incorrect. Arbitrage is a vega trade that is profitable when implied volatilities increase.

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