Managing pure and statistical equity arbitrage opportunities within the South African environment

Abstract

The analysis undertaken, firstly aims to identify the extent to which equities, their indexes and their derivatives priced in accordance with their fair value. Secondly, presuming that the traded values of the instruments do not in all instances equate to the fair value, the research aims to develop an effective means to identify and manage profitable opportunities arising from the mispricing.

General concepts relating to profitability, trade identification, risk and continuous improvement of the processes are addressed. This includes recommendations on the management of the risks through a structured reporting process.

The research looks at arbitrage trading in the South African market from the perspective of an empirical review into the market's participation in equity and equity derivative arbitrage. In addition to this empirical analysis, a time series analysis into various arbitrage strategies is conducted with the view to determining their relative profitability.

The first component of the empirical research focuses on the arbitrage trading strategies adopted by a sample of 80 institutions. Where the institutions trade arbitrage strategies, the research undertook to establish what methods are used to identify, trade and manage the index arbitrage, single stock futures arbitrage, risk arbitrage, statistical arbitrage and volatility arbitrage trading opportunities that present themselves within the South African Market.

Information gathered did not only focus on the actual trading strategies but also determined the relative cost structures, profitability and risk management processes that are employed to support these trading initiatives.

The time series analysis focused on index futures, single stock futures, risk, dual listed and statistical arbitrage methods, and reflects the results before and after transaction costs. These arbitrage strategies were applied to the ALSI Top 40 index or its associated shares and generally spanned a period of about four years.

Finally the research presents an arbitrage business model that is aimed at providing a blue print for arbitrage trading which covers:

new arbitrage strategy, implementation, market risk, execution, profit, traders, cost

Finally, the research provides a multiple regression method for application in identifying further arbitrage trading opportunities within the South African environment.