Convergence arbitrage

Edwin · Apr 28, 2015

Hi Colin,

How do you think the convergence arbitrage in the April 2008 paper HERE;- http://www.acted.co.uk/forums/showthread.php?t=565 compares with the one that was done by LTCM?

LTCM - The hedge fund’s investment strategy was known as convergence arbitrage. A very simple example of what it might do is the following. It would find two bonds, X and Y, issued by the same company that promised the same payoffs, with X being less liquid (i.e., less actively traded) than Y.
The market always places a value on liquidity. As a result the price of X would be less than the price of Y. LTCM would buy X, short Y, and wait, expecting the prices of the two bonds to converge at some future time.
When interest rates increased, the company expected both bonds to move down in price by about the same amount, so that the collateral it paid on bond X would be about the same as the collateral it received on bond Y. Similarly, when interest rates decreased, LTCM expected both bonds to move up in price by about the same amount, so that the collateral it received on bond X would be about the same as the collateral it paid on bond Y
Click to expand...

My thinking is being traded off for memorizing core-reading and trying to see how questions are best answered, im avoiding anything too consuming now and will appreciate your help.

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Convergence arbitrage

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Convergence arbitrage

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