Various Types of Arbitrage Strategies

This paper reviews the theoretical methods and the empirical results of various types of arbitrage strategies in past numerical studies. Although arbitrage can be generally dividend into two categories including risk-free arbitrage and risky arbitrage, there is still a certain level of risk which arbitrageurs should take, no matter what kinds of arbitrage. Since there are limitations and transactions costs in conducting arbitraging strategies, the profit of arbitrage may be plentiful in theory but it could be misleading in practice after considering transactions costs and potential risk. It appears that all arbitrage strategies are theoretically sound, but it is debatable that arbitrage strategies will succeed in the real world. The key factors for arbitrage strategies to succeed depend on how to identify various types of arbitrage strategies, exploit market inefficiency, to reduce transaction costs, and to evaluate potential risk.Chapter 1 Introduction 1 Chapter 2 Theoretical Background 4 2.1 Arbitrage Theory 4 2.2 Efficient Market Hypothesis (EMH) 6 2.2.1 Return anomalies 7 2.2.2 Momentum and contrarian effect 8 2.2.3 Event study 9 2.2.4 Insider trading 10 2.3 Behavioral Finance 10 Chapter 3 Various types of arbitrage 13 3.1 Fixed Income Arbitrage 13 3.1.1 Convertible Bond (CB) Arbitrage 13 3.1.2 Yield Curve Arbitrage 15 3.1.3 Corporate Bond Spreads Arbitrage 16 3.2 Parity Arbitrage 16 3.2.1 Index Arbitrage 16 3.2.2 Interest Rate Parity Arbitrage 18 3.2.3 Index Futures and Option Arbitrage 19 3.2.4 Put-Call Parity Arbitrage 21 3.2.5 Foreign Exchange Rate Arbitrage 21 3.3 Event Driven Arbitrage 23 3.3.1 Merger and Acquisitions Arbitrage 23 3.3.2 Ex-dividend Arbitrage 24 3.3.3 Momentum Strategies 25 3.4 Relation Arbitrage 25 3.4.1 Depositary Receipts (DR) Arbitrage 25 3.4.2 Pairs Trade Arbitrage 26 3.5 Statistical Arbitrage 27 3.5.1 Statistical Arbitrage 27 3.5.2 Alpha Arbitrage 27 Chapter 4 Limitations of Various Types of Arbitrage 29 4.1 Limitations of Fixed Income Arbitrage 29 4.1.1 Limitations of Convertible Bond (CB) Arbitrage 29 4.1.2 Limitations of Yield Curve Arbitrage 30 4.1.3 Limitations of Corporate Bond Spread Arbitrage 30 4.2 Limitations of Parity Arbitrage 31 4.2.1 Limitations of Index Arbitrage 31 4.2.2 Limitations of Interest Rate Parity Arbitrage 32 4.2.3 Limitations of Index Future and Option Arbitrage 32 4.2.4 Limitations of Put-Call Parity Arbitrage 33 4.2.5 Limitations of Foreign Currency Arbitrage 33 4.3 Limitations of Event Driven Arbitrage 34 4.3.1 Limitations of Merger and Acquisitions Arbitrage 34 4.3.2 Limitations of Ex-dividend Arbitrage 34 4.3.3 Limitations of Momentum Strategies 35 4.4 Limitations of Relation Arbitrage 35 4.4.1 Limitations of Depositary Receipts (DR) Arbitrage 35 4.4.2 Limitations of Pairs Trade Arbitrage 36 4.5 Limitations of Statistical Arbitrage 36 4.5.1 Limitations of Statistical Arbitrage 36 4.5.2 Limitations of Alpha arbitrage 37 Chapter 5 An Example of Convertible Arbitrage 38 Chapter 6 Conclusions 44 Appendix A 47 A.1 Issued Data of Convertible Bond of Aruotek Company 47 A.2 Issued Data of Convertible Bond 1 of Aker Company 48 A.3 Issued Data of Convertible Bond 2 of Aker Company 49 References 5