Merger options and risk arbitrage federal reserve bank of new. An index future entitles the buyer to any appreciation in the index over and above the index futures price and the seller to any depreciation in the index from the same benchmark. A person who engages in arbitrage is called an arbitrageur. Pdf improving the statistical arbitrage strategy in. Merger arbitrage, also known as risk arbitrage, is a strategy that attempts to capture the. Merger arbitrage is the purchase and sale of the stocks of two merging companies at the same time with the goal of creating riskless profits. Cash deal mergers while returns to merger arbitrageurs have shrunk in recent years, there still is wide interest in a. Sell short on the stocks in the index for the duration of the index futures contract. Last year, hillary clinton made a public plea for pharmaceutical companies to keep their costs down amid a scandal involving us pharma giant valeant, in which she singled out a drug produced by. Regulatory arbitrage usury laws capital rules economic substitutes session v tax arbitrage 1252017 converting one type of income into a more favorably taxed type of income session vi hedged investment strategies 12192017 longshort strategies market neutral strategies closedend fund arbitrage. Relative implied volatility arbitrage with index options another look at market efficiency1 manuel ammann and silvan herriger2 authors addresses. Also, based on the strong sharpe ratio, the arb hp strategy seems to handily outperform all the hedge fund indexes. Laffitte capital managements risk arbitrage fund is up 5. Index arbitrage is a form of program trading activity that can produce sudden and possibly sharp market movements.
An investor that employs this strategy is known as an arbitrageur. Risk arbitrage, also known as merger arbitrage, is an investment strategy that speculates on the successful completion of mergers and acquisitions. Index arbitrage an investment trading strategy that exploits divergences between actual and theoretical futures prices. Russell investments relative value investment strategies 2 the chart below illustrates the potential sources of return and the possible risks investors should consider when deciding whether to utilize a relative value strategy. In particular, the content does not constitute any form of advice, recommendation, representation, endorsement or arrangement by ft and is not intended to be relied upon by users in making or refraining from making any specific investment or other decisions.
Four essays in statistical arbitrage in equity markets jozef rudy. The hfri merger arbitrage index has exhibited a sharpe ratio of 0. Merger arbitrage investment an effective strategy for high. An investment strategy that attempts to profit from the differences between actual and theoretical futures prices of the same stock index. An application to stock option portfolio management vincenzo bochicchio, niklaus buhlmann, stephane junod and hansfredo list. Chapter 4, international arbitrage, shows how arbitrage influ. Merger arbitrage the journal of alternative investments. Merger arbitrage is one of the most commonly used strategies but paradoxically one of the least known.
Merger arbitrage is a type of eventdriven investing, which is an investing strategy that seeks to exploit pricing inefficiencies that may occur before or after a corporate event, such as a bankruptcy, merger, acquisition or spinoff. This strategy, referred to as merger arbitrage or risk arbitrage, attempts to cap. These imperfections include transactions costs and limited access to the proceeds generated by short sales. Improving the statistical arbitrage strategy in intraday trading by combining extreme learning machine and support vector regression with linear regression models conference paper pdf available. An example is the simultaneous buying selling of stock index futures i. Merger options and risk arbitrage peter van tassel federal reserve bank of new york staff reports, no. Passive investment strategies and efficient markets. Limited risk arbitrage by using an efficient markov chain approximation scheme i. A number of challenges arise in managing arbitrage strategies, many of which have already been discussed.
For example, when deal risk is not priced, the riskneutral probability of deal success is. Relative implied volatility arbitrage with index options. In this article, we will attempt to build a trading system based on the third type of risk premium. Block 2006 found that merger arbitrage hedge funds are able to earn strong returns in var. Merger arbitrage or other types of eventdriven investing can be highly profitable to investors who spend the time to do their research or to read this website. To evaluate the arbitrage pricing of an index future, consider the following strategies. We analyze the characteristics of the arbitrage strategies. The modeling techniques used range from a simple ordinary least. Risk arbitrage is a type of eventdriven investing in that it attempts to exploit pricing inefficiencies caused by a corporate event. Proshares merger etf mrgr index benchmark proshares etfs. Relative impliedvolatility arbitrage with index options manuel ammann and silvan herriger in the study reported here, we investigated the efficiency of markets as to the relative pricing of similar risk by using implied volatilities of options on highly correlated indexes and a statistical arbitrage strategy to profit from potential mispricings. Pinebridge investments merger arbitrage funds never really gained any traction. Merger arbitrage strategy beat the market consistenly.
Offers a rulesbased approach for executing a merger arbitrage strategy. But what merit additional comment are the sustainability of arbitrage strategies and how they are influenced by firmlevel resources, particularly management capabilities, as opposed to marketlevel differences in prices, costs, et cetera. An investment strategy that attempts to profit from the differences between actual and theoretical futures prices of the same. Index arbitrage is a subset of statistical arbitrage focusing on index components. Etfs investing strategies equity, index, options and etf arbitrage. I deal largely with classic arbitrage, which is riskless and selffinancing. Merger arbitrage a fundamental approach to eventdriven investing helps readers understand the inner workings of the strategy and hedge funds which engaged in this investment strategy. This is particularly important in merger arbitrage, where deal failure is a key risk. Arbitrage can also be used to buy and sell two stocks, two commodities and many other securities.
The good news is that this arbitrage is very forgiving. Apr 14, 2019 merger arbitrage is the purchase and sale of the stocks of two merging companies at the same time with the goal of creating riskless profits. It addresses pair trading strategies in various time frames ranging from a minute to daily data and it also addresses various modeling techniques. Cash deal mergers while returns to merger arbitrageurs have shrunk in recent years, there still is wide interest in a merger arbitrage investment strategy by hedge fund managers the high rollers. The benefit of focusing on the intuition of arbitrage comes at a cost. A strategy designed to profit from temporary discrepancies between the prices of the stocks comprising an index and the price of a futures contract on that index. Index arbitrage program trading description of terms. Arbitrageurs love an asset like an index that has lots of different securities based on its value because it creates lots of opportunities for mispricing. There are many deals happening in any given year, and the best way to generate steady returns is to invest only in the few that offer the best riskreward profiles. We want the index to be positively correlated to the stock that will be hedged. A form of arbitrage in which an investor takes advantage of discrepancies in price between a stock index and a futures contract on that index. How to profit from eventdriven arbitrage is the definitive guide to the ins and outs of the burgeoning merger arbitrage hedge fund strategy, with realworld examples that illustrate how mergers work and how to take advantage of them. Returns are generated by isolating and bearing deal risk risky application of the law of one price o conditional on deal success, there is a perfect substitute o if the deal fails, there is no opportunity.
The main risk in any merger arbitrage trade is that the deal fails to close. With ucits versions of the strategy liquidating, david stevenson asks if there is still any interest. Index arbitrage as a day trading strategy if you have decided to add arbitrage to your bag of day trading strategies, consider index arbitrage. Hedging merger arbitrage strategy spread risk new york life. Jan 11, 2017 derivative strategies in risk arbitrage published on. Triangular arbitrage in forex market what is arbitrage. Index arbitrage occurs when an arbitrageur takes one position on a stock index or on the individual stocks underlying the index while taking an equal but opposite position on a futures contract on the index. Arbitrage strategies convertible arbitrage stock price.
In the world of finance, arbitrage is the practice of taking advantage of a state of imbalance between two or more markets. Again, if s is the spot price of the index, f is the futures prices, y is the annualized dividend yield on the stock and r. Foreknowledge of the likelihood of an impending program trade can help investors with the timing of initiating either long or short positions in stocks, index. Merger arbitrage investment an effective strategy for high rollers and small time investors. G00, g12, g34 abstract option prices embed predictive content for the outcomes of pending mergers and acquisitions. Again, if s is the spot price of the index, f is the futures prices, y is the annualized dividend yield on the stock and r is the riskless rate, the arbitrage.
Both strategies require the same initial investment have the same risk and should provide the same proceeds. Risk arbitrageurs adopt different trading strategies based on the type of deal that is struck between the acquiring firm and the target firm. The portfolio manager opportunistically allocates capital among the various strategies in an attempt to create the best riskreward profile for the overall fund. You can use a number of different methods successfully. As a measure of the volatility skew, we use the cboe skew index. A quantitative strategy for enhancing merger arbitrage. Optimal arbitrage strategies on stock index futures under position limits min dai1 yifei zhong2 yue kuen kwok3 4 assuming the absence of market frictions, deterministic interest rates, and certainty in dividend payouts from the stocks in the index basket, an arbi. The return derived from a risk arbitrage strategy depends. The index includes long positions for all eligible deals, and short positions for eligible stock and cashstock deals. We can manage the risk by hedging the total risk exposure when the broad index turns down. By buying either the stocks or the futures contract and selling the other, an investor can sometimes exploit market inefficiency for a profit. This index measures monthly perfor mance of an equally weighted pool of hedge funds following the merger arbitrage strategy. Designed to provide an alternative source of returns not correlated to a portfolios equity market holdings.
The arbitrageur exploits the imbalance that is present in the market by making a couple of. In the last section, we summarize the results and present conclusive remarks about the index arbitrage strategies on stock index futures under position limits. You can be late to enter or late to exit and still have good profits. A volatility skew based trading strategy relative value. Index arbitrage financial definition of index arbitrage. For example, when the riskfree interest rate was 3. The etf tracks an index that consists of the same for equities, but two shares of each stock are in the index. Session iii index arbitrage 11212017 trading triggers index funds tailing triple witching hour. Relative impliedvolatility arbitrage with index options. In 1970, there were 355 equity mutual funds holding broadly diversified portfolios. The index seeks to achieve capital appreciation by investing in global companies for which there has been a public announcement of a takeover by an acquirer. Dec 17, 2012 merger arbitrage etfs just got better. Derivative strategies in risk arbitrage published on. Understanding arbitrage an intuitive approach to financial analysis.
Merger arbitrage is one of the most commonly used strategies but. Merger arbitrage also known as risk arbitrage is an investment strategy that always consists of buying shares of the company that is being acquired in a merger or acquisition the target firm. All content on is for your general information and use only and is not intended to address your particular requirements. Merger arbitrage, an original darling of hedge fund strategies, has gone through some tough times. Modeling risk in arbitrage strategies using finite mixturesx citeseerx. The iq merger arbitrage etf seeks to track, before fees and expenses, the performance of the iq merger arbitrage index. A brief guide to merger arbitrage vintage value investing. The msci world index is a freefloat adjusted market capitalization weighted index that is designed to measure the equity market performance of developed market performance data assumes reinvestment of dividends, but it does not reflect management fees, transaction costs or. Merger arbitrage etfs just got better seeking alpha. Returns for the iq merger arbitrage index do not reflect the deduction of management fees, taxes and other expenses. The hennessee multiple arbitrage index includes funds that employ more than one arbitrage strategy. Four essays in statistical arbitrage in equity markets.
Figure 4 shows how few mutual funds have achieved above index returns over the period from 1970 through 2001. Gallen swiss institute of banking and finance rosenbergstrasse 52 ch9000 st. The msci world index is a freefloat adjusted market capitalization weighted index that is designed to measure the equity market performance of developed market performance data assumes reinvestment of dividends, but it does not. Equity, index, options and etf arbitrage the balance. Pure arbitrage, where, in fact, you risk nothing and earn more than the riskless rate. Index iqs etf is contingent on the relative performance of the targets in an acquisition. A statistical analysis of hundreds of merger arbitrage opportunities.
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