Abstract
This paper examines the information content of option holdings of risk arbitrageurs after merger or acquisition announcements. A portfolio mimicking risk arbitrageurs’ post-announcement option and stock holdings delivers higher risk-adjusted returns than their stock-only portfolio. To understand the economic channel, we show that the option positions of risk arbitrageurs predict post-announcement stock price volatility and deal outcomes, but not the direction of stock prices. Hence, risk arbitrageurs do not only mechanically provide liquidity to selling shareholders but they are skilled to process the deal consummation probabilities. Indeed, risk arbitrageurs exploit the ‘risk’ in risk arbitrage by employing profitable straddles.
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