Risk-Arbitrage Spreads and Performance of Risk Arbitrage

Abstract

This article explores the cross sectional variation in risk arbitrage spreads. Factors that are relevant to the probability of deal success (i.e., target termination fees, target resistance, target price run-up, relative size of the target, and arbitrageurs9 activity), bid revision (i.e., target9s growth opportunity), potential loss when a deal fails (i.e., bid premium and bidder9s systematic risk) and transaction costs for risk arbitrageurs (i.e., bidder9s return volatility and low priced shares) are found to be significant in developing a prediction model for risk arbitrage spreads. Risk arbitrage portfolios are created by comparing predicted arbitrage spreads with actual arbitrage spreads. The results show that deals whose actual spreads exceed the predicted spreads tend to be more attractive investments. The model may be used by risk arbitrageurs to identify attractive risk arbitrage opportunities.