| A convertible bond is a bond that can be converted to the underlying stocks at a specific time and a specific conversion conditions. As a hybrid derivative combining the characteristics of stocks and bonds, the convertible bond has become an indispensable part of the financial market. From the issuer’s perspective, the cost of raising money is lower than the cost of the equity and debt financing. Another key benefit is to improve the structure of assets and liabilities. So the convertible bond is a flexible tool for financing. For investors, the convertible bond holder can hold upon maturity for repayment of principal and interest, can also choose to gain profit upside of conversion into underlying stock. It is also a flexible investment tool. Because of the multiple attributes, the convertible bond attracts a variety of investors. In recent ten years, Chinese convertible bond market is developing at unprecedented rate and amount for its refinancing market. It has also played a positive role for the prosperity of the financial market.Convertible bonds in a mature financial market have been widely used into portfolio shorting the underlying stocks to gain the risk-free or low-risk arbitrage. Over the past15years, the convertible arbitrage has become one of the main trading strategies of international hedge funds. In recent years, Chinese convertible bond market increases continuously and quickly, but the benefits of convertible bonds, especially the function of convertible arbitrage, can’t be fully developed without the short selling. After March31,2010, the Securties Margin Trading starting in Shenzhen and Shanghai stock markets shows that the short selling mechanism was born in Chinese stock market. It helps the optimizations of the portfolio with convertible bonds and its underlying stocks, arbitrage strategies, and portfolio risk and return. How to effectively use the Securities Margin Trading to gain the convertible bond arbitrage have become new challenges of Chinese convertible bonds theoretical and empirical research.Prior to the introduction of Securities Margin Trading, the gains of Chinese convertible bond arbitrage are difficult to achieve due to the obstacles and great risk from the markets. But after the introduction of Securities Margin Trading the profit model of China’s securities market has changed, which is helpful for the achievement of new arbitrage strategies. The arbitrage strategy between convertible bonds and securities lending portfolio is an important strategy to benefit from Securities Margin Trading. When the convertible bond market price is lower than the conversion value, the conversion premium is negative, which has the arbitrage opportunities. Investors can buy convertible bonds and promptly convert into shares to sell at the current stock price, to gain the arbitrage of the conversion value and the market value. Therefore, China’s introduction of Securities Margin Trading is very significant on the development of China’s securities market. It helps achieve arbitrage strategies between convertible bonds and their underlying stocks to reduce portfolio risk.Based on the theories of convertible bonds, this paper analyzed Chinese convertible bonds market situation and provision. The United States, as the birthplace and the world’s largest convertible bond market, has accumulated successful experience. Comparing the market capitalization, provision, risk&return and arbitrage between the Chinese and American convertible bond market, the results show the commonalities and differences. It provides references to improve Chinese convertible bond market.The theoretical analysis shows that the convertible bond value is influenced by the underlying stock’s price and volatility. This paper investigates the convertible bonds traded in the Chinese market after Securities Margin Trading issues. It shows that the portfolio of convertible bonds and underlying stocks will appear arbitrage opportunity in the process of the price fluctuation during the conversion period. Furthermore, the paper analyzes the price’s volatility asymmetry between convertible bonds and underlying stocks.Delta arbitrage strategy is the most common trade, which involves longing the convertible bonds and shorting the underlying stocks. According to the changes of Delta value, the investors decide the quantity of short selling stock, gaining Delta neutral arbitrage. After the Securities Margin Trading issues, convertible bond arbitrage strategies have been introduced to Chinese security market. The paper is the first user of Delta arbitrage model in Chinese convertible bonds market to do in-depth empirical research on comparing T date and T+1date margin arbitrage profits. Finally, the paper analyzes the choices of convertible arbitrages and its application in portfolio as well.Therefore, on the basis of theoretical study on the convertible bond, the paper does empirical research on risk and return characteristics, arbitrage opportunities, and Delta arbitrage strategy. After the Securities Margin Trading, it provides not only theoretical and empirical evidence for convertible arbitrage strategy of Chinese security market, but also important reference for investors.The innovatons of this paper can be summarized as the following four points:First, the empirical analysis of Chinese convertible bonds’risk&return characteristics under the Securities Margin Trading reveals China’s convertible bonds relative to its underlying stock with high return and low risk. Through empirical discovery, the convertible bond price and the underlying stock price have significant positive correlation, but it is not necessarily correlated with the underlying stock volatility, thus revealing the high-risk stock does not mean its convertible bonds with high risk.Second, using the method of function constructor based on the characteristic of Delta value, this paper proposes a new Delta value estimation model of convertible bonds. Compared with Polynomial Fitting Model, the new function model can ensure that the convertible bond prices and the underlying stock prices are positively correlated. Also, the first-order derivative is between0and1, the second-order derivative is positive. The new model solves the problem that the Polynomial Fitting Model can easily lead to the negative first-order and second-order derivatives.Third, through the empirical analysis on the Delta neutral arbitrage, the paper puts forward different decision thresholds of arbitrage space to affect the risk and return. It shows that the larger value of decision threshold is not always the better one. The paper proposes a decision thresholds optimization. When the arbitrage space is greater than or equal to the threshold value, it will trigger arbitrage strategy.Fourth, based on the parameter statistic analysis method and model of Delta arbitrage model, the paper studies the market validity tests, the arbitrage analysis, stock volatility estimation and Delta valuation. Comparing the risk difference of Delta arbitrage strategy between Security Margin and Non-security Margin, it confirms the margin return has leverage effect, but at the same time, the risk also has a leverage effect. With comparison of T+0and T+l trading strategy of arbitrage return, it verifies that the investors face a smaller return and a greater risk uner the T+1trading strategy than T+0trading strategy. It shows the increasing effects of costs and risk on securities investment. |
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