Is Bond Arbitrage Still Around?
So I just started When Genius Failed (really liking it) and it speaks quite a bit about bond arb, one of the main strategies used by LTCM.
Obviously, bond markets are much more efficient now than they were when LTCM was starting up and when Salomon had a wildly succesful bond arb unit.
On the other hand, there are still spreads which seem ripe with opportunities similar to the ones LTCM was trying to exploit.
Please forgive my ignorance, but do bond arb desks/units still exist? It seems like a very interesting field.
Bond arb does still take place, though not as profitably as in its heyday. I haven't read it, but I assume When Genius Failed describes how LTCM took advantage of how government bonds with identical credit risk traded at different spreads due to illiquidity. Illiquidity still causes mispricings that can be taken advantage of in arbitrage strategies.
Another type of common (though frequently unappreciated) bond arb is convertible bond arbitrage. It's existence is also largely due to illiquid convertible bond markets and how this can lead to mispricing: http://www.eurekahedge.com/news/03jul_archive_cba.asp
Yeah, he still posts here.
Haha I'm almost done with when genius failed and I was thinking the same thing. It seems like they use quantitative methods to get an extremely precise return, compared to qualitative aspects of equities that are much more volatile.
I think its crazy how they got those returns of 2-3% and with their cheap leverage are able to show like 50% returns.
Next chapter is when they failed.. so maybe it's not all good.
Well done WSO with the amazon referral links.. getting smart.
LTCM was basically a global macro fund with a heavy quantitative bent. Almost like stat arb, but with lower frequency. Calling what they did "bond arbitrage" is missing the point...
if you are talking about fixed income RV style investing, i think there was a thread on here a while back featuring the guy who runs the Barnegat fund--there are still some people playing in this space. and no, i wouldn't call them lower frequency stat arb, or what statistical arbitrage is today--though one of their equity guys mentioned in the book runs a statistical arbitrage fund today
The whole LTCM model is still around and kicking - in this rate environment especially a lot of the old tricks are heavily in use. Buying o10s-10s and auction plays have been publicized to death but surprisingly it still works. A lot of the tricks are just used with lower leverage (and correspondingly lower returns). RV in govt bonds is still there. LTCM was not a "global macro fund with a quant edge" - that description is so far from the truth to be laughable. They were a bunch of guys who were short vol and clipped liquidity premium, nothing more. All the math and tricks were to just express different views of the same thing.
How were they not global macro? They played mostly in rates across various markets.
How did they not have a quant edge? You just admitted they used "math and tricks". I didn't say they were a heavy quant shop. But their RV trades were grounded in mean-reversion bias.
I would check out Nektar that's run by Kent Janer. It's a fixed income RV fund which incorporates enough macro awareness to not blow up every few years. He was "the House" in Drobny's book The Invisible Hands.
dealer treasury desks will either have an "off the run" guy or a 5yr guy who will trade the otr and everything else in the box. there are a few micro rv only guys around but most are general rates rv guys who use that toolbox. there are only so many storylines so it's a good annuity if you're a macro guy but can wade through the curve.
Just playing in rates doesn't make you global macro. Global macro as a style is about seeing larger trends/capital flows/dislocations. LTCM was not that. They are "quant" but they are DEFINITELY not "global macro".
optimus_prime, whats your background?
it is still around look into the "Ho-Lee Model"
There was nothing magical about LTCM, they were just a fixed income relative value shop that took on way too much leverage and blew up. Yes there are still quite a few hedge funds that do this, however the herd was thinned significantly in 2008 when many of the RV guys (including Merryweather once again) were wiped out.
And what they did was in no way "arbitrage" or at least not as that term is defined in college classes. There are many risks involved in these types of trades even if they appear to be "rsikless"...one has to fund the trade, there are margin issues, etc. Relationships between bonds can remain out of whack far longer then a highly leveraged hedge-fund can stay solvent.
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