4. Excess returns for different merger arbitrage strategies.
|
|
Return, % |
HFRX Merger Arbitrage Index return, % |
Excess return, % |
|
Portfolio 1 |
2,7% |
0,3% |
2,4% |
|
Portfolio 2 |
2,7% |
0,3% |
2,4% |
|
Portfolio 3 |
2,9% |
0,3% |
2,6% |
|
Portfolio 4 |
4,2% |
0,4% |
3,8% |
paper contributes to literature by outlining an “easy to implement” way to estimate risk-neutral probability of a M&A deal success from option prices and conducting empirical analysis of its predictive power on the basis of a sample of cash tender offers for the period of 4 years (2010 to 2013). In conclusion, empirical study suggests that option prices embed significant predictive content for forecasting outcomes of cash acquisitions. Forecasting power of the risk-neutral probabilities increases monotonically closer to the resolution date. However, despite the above-mentioned inference risk-neutral probability forecasts appear to be poorly calibrated. Options market tends to under predict the probability of success, suggesting excess returns opportunities. The above-mentioned inference provides a starting point for further research that could focus on option market arbitrage strategies for companies that are subject to a takeover bid.
Comparative analysis of option implied and stock-implied
probabilities suggest that both probability estimates are worth of
consideration. For the period shortly after the announcement date stock market
reacts to strongly and tends to over predict the success probability, while
option market provide more accurate forecasts. Closer to deal resolution,
however, stock market adjusts and “naïve”
stock-derived probabilities become better estimates than risk-neutral ones. Additionally, combination
of stock market and option market probability forecasts outperform models based
on isolated information from either of the markets. All of the above suggests
that proposed method for risk-neutral probability estimation could be of use in
relation to deal outcome prediction, especially when used together with other
probability estimating models. basic analysis of excess returns associated with
merger arbitrage reveals that on the basis of the chosen sample a portfolio of
high risk-neutral success probability stocks generate a slightly higher excess
return than a simple “invest in all” portfolio. This empirical finding provides
a vast area for further research. For example, the study could extend to
determine the optimal portfolio weights that should be assigned to stocks
depending on their option-implied success probability. in all, risk-neutral
probability estimates obtained in this paper could serve as a starting point
for analysis of arbitrage strategies in both, derivatives and stock market. It
should be also mentioned, however, that probabilistic forecasts’ estimation and
testing, especially of those that rely on option market, put many restriction
on the sample data and have, indeed, limited area of application.
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