Merger Arbitrage and Idiosyncratic Risk

This paper identifies a merger arbitrage risk factor that is superior to market beta in explaining the risks assumed by a merger arbitrage portfolio. Previous research has documented a weak tie between market beta and merger arbitrage returns. Mitchell and Pulvino (2002), for example, note that the beta to a merger arbitrage strategy appear to be nonlinear; they are close to zero in a flat to rising market but large in a falling market. However, when our risk factor is added to market beta in a two-factor risk model, the resulting beta cannot be statistically distinguished from zero in all market conditions.