Examining the recent rising preferred perpetuals and its market anomaly in high yield space

Abstract

Since late 2017 when the worldwide business optimism was at its highest, highly leveraged energy companies began to issue unique preferred shares that have character of perpetual subordinated bond and that trade in bond market. Among those firms, DCP Midstream issued another preferred shares that have same feature, but trade in mezzanine market. This paper explores the recent rising preferred shares and its market inefficiency, especially between bond market (par 1000) and mezzanine market (par 25). Assuming the firm exercise its call option for both securities, the paper finds that one can construct a profitable arbitrage strategy with annual Sharpe ratio of 1.775 from these two almost identical securities. My results bring some empirical substance to the discussion on the law of one price in financial markets. Although there are some limitations such as transaction costs and liquidity issues, this market has a degree of inefficiency.