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RFS Advance Access originally published online on July 6, 2006
Review of Financial Studies 2005 20(3):769-811; doi:10.1093/rfs/hhl026
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Risk and Return in Fixed-Income Arbitrage: Nickels in Front of a Steamroller?

Jefferson Duarte
University of Washington

Francis A. Longstaff
UCLA Anderson School and the NBER

Fan Yu
UC Irvine

Address correspondence to: Francis Longstaff, Anderson School at UCLA, 110 Westwood Plaza, Los Angeles, CA 90095-1481, or e-mail: francis.longstaff{at}anderson.ucla.edu.

We conduct an analysis of the risk and return characteristics of a number of widely used fixed-income arbitrage strategies. We find that the strategies requiring more "intellectual capital" to implement tend to produce significant alphas after controlling for bond and equity market risk factors. These positive alphas remain significant even after taking into account typical hedge fund fees. In contrast with other hedge fund strategies, many of the fixed-income arbitrage strategies produce positively skewed returns. These results suggest that there may be more economic substance to fixed-income arbitrage than simply "picking up nickels in front of a steamroller."


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