FIVY - Corporate Hybrids Arbitrage: Trading The Ebbs And Flows Of Extension Risk

2025-02-11 06:00:00 ET

Summary

• The structural incentives for an issuer to call a European-style hybrid at its first call date are very strong.
• Particularly during periods of risk aversion, market participants tend to price European-style hybrids more like U.S.-style hybrids, in line with economic rather than structural call incentives.
• During periods of general risk aversion, many European-style hybrids are priced as though they are U.S.-style hybrids, with lower-reset hybrids trading at relatively wider market spreads than higher-reset-spread hybrids.

By Linus Claesson, CFA & Robin Usson

Is there structural mispricing in Corporate Hybrids?

In previous articles, we have described the differences between "European-style" corporate hybrid securities (the structures with coupons that are "stepped up," first issued in Europe, but long popular in markets such as Canada and Australia) and "U.S.-style" hybrids (those without coupon step-ups, chiefly issued in the U.S.). The structural incentives for an issuer to call a European-style hybrid at its first call date are very strong, and we believe they almost always override economic incentives not to call. The history of the asset class supports this belief....

For further details see: