Characteristics of Risk and Return in Risk Arbitrage

54 Pages Posted: 30 May 2001  

Mark L. Mitchell

AQR Capital Management, LLC; CNH Partners

Todd C. Pulvino

AQR Capital Management, LLC; CNH Partners

Date Written: October 2000

Abstract

This paper uses a sample of 4,750 stock swap mergers, cash mergers, and cash tender offers during 1963 - 1998 to characterize the risk and return in risk arbitrage. For out-of-sample comparison, we also examine the risk/return profile for a sample of active risk arbitrage hedge funds during 1990 - 1998. Results from both samples indicate that risk arbitrage returns are positively correlated with market returns in severely depreciating markets but uncorrelated with market returns in flat and appreciating markets. This result suggests that returns to risk arbitrage are similar to those obtained from selling uncovered index put options. Although linear asset pricing models provide reasonable estimates of the excess returns in risk arbitrage, a contingent claims analysis that incorporates the non-linearity in returns provides a more accurate description of the risk/return relationship. After controlling for both the non-linear return profile and transaction costs, we find that risk arbitrage generates excess returns of 4% per year.

Keywords: Risk arbitrage, asset pricing, market efficiency

JEL Classification: G10, G12

Suggested Citation

Mitchell, Mark L. and Pulvino, Todd C., Characteristics of Risk and Return in Risk Arbitrage (October 2000). Available at SSRN: https://ssrn.com/abstract=268144 or http://dx.doi.org/10.2139/ssrn.268144

Mark L. Mitchell (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

CNH Partners ( email )

Two Greenwich Plaza
1st Floor
Greenwich, CT 06830
United States
(203) 742-3001 (Phone)

Todd C. Pulvino

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

CNH Partners ( email )

2 Greenwich Plaza
1st Floor
Greenwich, CT 06830
United States
203-742-3002 (Phone)
203-742-3072 (Fax)

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