Risk Arbitrage Profitability And Trading Strategy In China’s Stock Market

Risk arbitrage is a regular investment strategy in matured stock markets. InChina, as the stock market keeps developing itself, mergers and acquisitions arebecoming important events that drive the changes of stock prices, which will offermore opportunities for the arbitrageurs. This paper researches the profitability of riskarbitrage in China’s stock market and provides meaningful practice for risk arbitragetrading strategy design.241equity acquisition cases are collected from year2004to2011. By employingthe market model, we calculate the abnormal returns of the target companies’ stockprices after the first M&A announcements, and found that there are significantabnormal returns and cumulative abnormal returns (CAR) caused by the M&A events,indicating that risk arbitrage can be profitable in China’s stock market.Using the CAR as the proxy of risk arbitrage profitability, we investigate thefactors that can change investors’ expectation on the target companies’ performance inthe future, which results in different sizes of CAR. The results of our regressionmodel show that a target company with lower market capitalization, facing financialdistress or economic distress, having better quality or operation efficiency of assetsmay have higher CAR. Besides, cash payment in the M&A deals and abnormal returnin day1are also significantly positive to the size of CAR.Three risk arbitrage trading strategies are proposed, based on the characteristicsof the abnormal returns and the factors that influence the profitability of risk arbitrage.And all the three trading strategies outperform the corresponding samples’ overallprofitability.