The Profitability of Merger Arbitrage: Some Australian Evidence

Abstract

In this paper we examine the risk-adjusted profitability of merger arbitrage in Australia. Using a sample of 193 merger and acquisition bids from January 1991 to April 2000, we construct a time series of returns on equal and value-weighted merger arbitrage portfolios. Benchmarking the returns on the merger arbitrage portfolios against the CAPM and Fama and French (1993) three-factor models, we find that merger arbitrage generates statistically and economically significant excess risk-adjusted returns before transaction costs, ranging from 0.84% to 1.20% per month. However, after adjusting for transaction costs, the risk-adjusted returns are no longer statistically significant. Further, in contrast to the United States, our evidence indicates that merger arbitrage in Australia is a market-neutral investment strategy. Indeed, the results from our estimations of the linear CAPM and Fama and French (1993) three-factor models suggest that merger arbitrage returns are not significantly sensitive to market-wide factors.

Firm size, takeover profitability, and the effectiveness of the market for corporate control: Does the absence of anti-takeover provisions make a difference?

“…22 Unfortunately, we do not have access to short-interest data for our Australian sample, which would have provided clearer evidence of an increase in short-selling post-bid announcement. Maheswaran and Yeoh (2005) do, however, report similar results to Mitchell and Pulvino (2001) on the profitability of merger arbitrage using an Australian sample. Mitchell et al (2004) show that even after accounting for merger arbitrage, US stock acquirers continue to generate negative equally-weighed CARs, albeit statistically insignificant.…”

Market risk exposure of merger arbitrage in Australia

“…, 1992; Schwert, 1996; Branch and Yang, 2003 1 ) and 4.8 per cent in a small sample study from Canada (Karolyi and Shannon, 1999). 2 For calendar‐time portfolios, estimates of mean annualised abnormal returns include 4.0, 7.3, 22.4 and 28.3 per cent in the United States (respectively, Mitchell and Pulvino, 2001; Baker and Savasoglu, 2002; Branch and Yang, 2006a; Jindra and Walkling, 2004), 8.1 per cent in the UK (Sudarsanam and Nguyen, 2008) and 10.6 per cent in Australia (Maheswaran and Yeoh, 2005).…”

“…In Australia, Maheswaran and Yeoh (2005) estimate annualised abnormal returns of 10.6 per cent from value‐weighted portfolios of stocks subject to cash offers, which declines to 6.0 per cent once transaction costs and market impact are incorporated. However, they do not find statistical evidence of nonlinear exposure to market returns and therefore conclude that merger arbitrage in Australia is a market‐neutral investment strategy.…”

How's the Merger Arbitrage Strategy in China?

“…We assume that the single-factor market model is an adequate characterization of the rate of return of a stock. Nit = aci++iRMt + £it (2) where Rit is the daily return for firm ion day t. RMt is the daily return for market portfolio on the dayt. 8it is the random error(or firm-specific component of the return) for firm i on day t. ai,,/i are the market model parameters for firm i.…”

“…For example, Maheswaran and Yeoh examine 193 merger and acquisition bids from January 1991 to April 2002 and find that merger arbitrage portfolio generates statistically significant excess risk-adjusted return before transaction costs [2], Jindra and Walking show that passive arbitrage portfolio outperforms the market portfolio over the period from 1981 to 1995 [3]. Baker and Savasoglu report abnormal returns of about 1% per month on a portfolio of risk arbitrage positions established over the period 1978 through 1996 [4].…”