Case Study

Abstract

After coping with sagging equity volatility in the spring (and numerous concerns about how far it might fall), the emergence of a new round of corporate accounting issues combined with evidence of continued shaky operating results to generate more than enough volatility in the second quarter for convertible arbitrageurs. However, as is typically the case, the large upward volatility spikes were frequently accompanied by credit-spread deterioration and premium erosion among names where any operational question marks existed. The rocky environment has led to a renewed focus on risk management as managers reevaluate exposures across their portfolios. This activity has prompted sales in more speculative names, with a lack of buyers for this supply pressuring premiums in the associated issues. Meanwhile, however, arbitrageurs continue to have ample available buying power. As a result, among more “visible” names, implied volatilities rose slightly during this difficult period, and we believe will remain firm in coming months. In this case study, we provide an overview of convertible arbitrage trends and selected winner and loser arbitrage positions in the U.S., Europe, and Asia.