Merger Arbitrage

Merger arbitrage, also known as risk arbitrage, is an investment strategy that seeks to profit from the price discrepancies that arise during mergers and acquisitions. This strategy involves simultaneously buying and selling the stocks of two merging companies to capitalize on the spread between the current market price and the anticipated acquisition price.
== History ==
The origins of merger arbitrage can be traced back to the early 20th century during America's first major M&A wave. Notable figures like Ivan Boesky and Michael Milken gained prominence for exploiting market inefficiencies during the leveraged buyout boom of the 1980s. Warren Buffett demonstrated the effectiveness of risk arbitrage through Berkshire Hathaway in the 1970s and 80s, with his Capital Cities/ABC deal in 1985 earning a 50% annualized return on investment.
By the 1990s, hedge fund pioneers like Julian Robertson of Tiger Management had built fortunes using arbitrage strategies. The strategy has since become a cornerstone of the hedge fund industry, with dedicated merger arbitrage funds and multi-strategy funds incorporating it into their investment approaches.
== Strategy ==
The basic merger arbitrage strategy involves taking a long position in the target company's stock and, in the case of a stock-for-stock merger, a short position in the acquiring company's stock. The goal is to profit from the difference between the current market price of the target company's stock and the expected acquisition price.
In a cash merger, arbitrageurs buy the target's stock at a discount to the cash offer per share and hold until the deal closes. In a stock merger, they buy the target's stock and short the acquirer's stock in proportion to the exchange ratio specified in the merger agreement.
== Risks ==
Merger arbitrage is not without risks. The primary risk is deal failure, which can result in significant losses for arbitrageurs. Other risks include:
* Regulatory risk: Antitrust concerns or other regulatory issues can delay or prevent deal completion.
* Financing risk: In leveraged buyouts, the ability to secure funding can impact deal closure.
* Market risk: While generally considered market-neutral, extreme market conditions can affect returns.
* Time risk: Longer deal timelines can increase exposure to market fluctuations and reduce annualized returns.
== Notable Practitioners ==
Several prominent investors and hedge funds have successfully employed merger arbitrage strategies:
* Warren Buffett: Used merger arbitrage extensively in the early part of his career at Berkshire Hathaway.
* John Paulson: Founder of Paulson & Co., known for its successful merger arbitrage strategies.
* Ivan Boesky: A controversial figure known for his merger arbitrage activities in the 1980s, later convicted of insider trading.
== Performance and Market Impact ==
Merger arbitrage returns are generally considered to have low correlation with broader market returns, making it an attractive strategy for portfolio diversification. However, during periods of market stress, correlations can increase, potentially impacting returns.
The strategy's performance can be affected by various factors, including deal spreads, time to completion, market volatility, and the regulatory environment. Academic studies suggest that merger arbitrage returns may represent compensation for bearing the risk of deal failure rather than pure alpha generation. 
== References ==
Category:Hedge Fund Strategies
Category:Mergers and Acquisitions
Category:Arbitrage
Category:Investment Strategies
Category:Risk Management