risk arbitrage

Risk Arbitrage

A broad definition for three types of arbitrage that contain an element of risk:

1) Merger and Acquisition Arbitrage - The simultaneous purchase of stock in a company being acquired and the sale (or short sale) of stock in the acquiring company.

2) Liquidation Arbitrage - The exploitation of a difference between a company's current value and its estimated liquidation value.

3) Pairs Trading - The exploitation of a difference between two very similar companies in the same industry that have historically been highly correlated. When the two company's values diverge to a historically high level you can take an offsetting position in each (e.g. go long in one and short the other) because, as history has shown, they will inevitable come to be similarly valued.

Notes:

In theory true arbitrage is riskless, however, the world in which we operate offers very few of these opportunities. Despite these forms of arbitrage being somewhat risky, they are still relatively low-risk trading strategies which money managers (mainly hedge fund managers) and retail investors alike can employ.

See also: Arbitrage, Hedge Fund, Leveraged Recapitalization, Long (or Long Position), Short, Stub

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Risk arbitrage

Traditionally, the simultaneous purchase of stock in a company being acquired and the sale of stock of the acquirer. Modern risk arbitrage focuses on capturing the spreads between the market value of an announced takeover target and the eventual price at which the acquirer will buy the target's shares.

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risk arbitrage

The simultaneous purchase and sale of assets that are potentially, but not necessarily, equivalent. For example, Firm A may make an offer to acquire Firm B by exchanging one share of its own stock for two shares of Firm B's stock. If the stock of Firm A is trading at $50 and the stock of Firm B is trading at $23, the risk arbitrager would buy shares in Firm B and sell short one-half this number of shares in Firm A. If the buyout offer is approved, the two stocks will exchange on a one-for-two basis and the arbitrage position will be profitable. The risk is that the buyout will be unsuccessful and the exchange of stock will not take place. Risk arbitrage is also used in situations involving reorganizations and tender offers. Also called equity arbitrage.