Merger Arbitrage And The Profitability Of Risk Strategies

Merger arbitrage is a risky investment strategy that exploits pricing discrepancies in the market for corporate control. In this paper I examine the risk-adjusted profitability of merger arbitrage in China. Using a sample of 53 tender offers from July 2003 to December 2015, and 135 negotiated takeover bids from January 2005 to December 2015,I find that merger arbitrage would have done quite well during those M&A events.In the case of tender offer, several strategies such as buying the target stock on announcement of the summary report and holding until the day that the official report disclose, or buying on the later announcement day and holding until completion of the bid to capture the arbitrage spread, can generate positive excess return. Cumulative excess return from strategies with short time holding period is even remarkable in the case of negotiated takeover. Besides event study, I also construct a time series of returns on value-weighted merger arbitrage portfolios. Benchmarking the returns on the merger arbitrage portfolios against the CAPM, I find that merger arbitrage can generate statistically and economically significant excess risk-adjusted returns, ranging from 19.12%(arbitrage on tender offers)to 104.72%(arbitrage on negotiated acquisitions) per year. In contrast to the United States and other sophisticated capital markets, these findings imply that merger arbitrage is quite profitable in China as long as appropriate strategies are applied to.In addition, a multiple linear regression model is also included in this paper in order to explore the characteristics that may influence the arbitrage return. The results indicate that:① In the case of tender offer, merger arbitrage return would be larger if the acquirer controls higher percentage of the target shares and the bid price seems higher relative to the weighted average price 30 days prior to the announcement. The run-up of the target stock price before the announcement also implies a higher arbitrage return. On the contrast, tender offers that aim to terminate the listing of target stocks would significantly drive down yields. ② In case of negotiated acquisitions, however, abnormal returns are insensitive to various attributes of the deal, such as the price premium, the proportion and amount of the deal, the status of the transferor and the transferee as stock holders in the target company. One of the variables that show significance is the increase of stock price on the announcement day. The higher the run-up, the larger the arbitrage returns. These results have implications for merger arbitrage, though puzzle still remains about what drives the abnormal return in negotiated acquisitions.