Practical Applications from the Experts - August 2009

categories: Product Documentation, general

Merger Arbitrage Model

RiskMetrics has introduced a new mathematical framework to capture the principal risk of deal failure inherent in merger arbitrage deals. The approach involves the simulation of random variables that reflect the deal success, deal length and calculates the implied probability of success from the market price of the equity. The model covers cash, equity and hybrid merger arbitrage deals.

A sample report below shows the comparison of risk numbers (analysis date: June 30th) produced by the traditional model and the Merger Arbitrage model. The details of the merger deals covered in the report are as follows.

NCX shows a significant decrease in its VaR numbers using the Merger Arbitrage model. This happens to be the case because the stock was trading very near to the bid level leading up to the analysis date. This implies a small risk of deal failure and hence the lower VaR number.

CTX shows a comparable risk number using the new model. Since this is an equity deal, the risk of CTX is dominated by the risk of it’s acquirer’s stock (Pulte Home). Attached is a graph that depicts the interplay of the two stock prices.

SGP risk numbers reflect a blend of the risk inherent in hybrid deals i.e. the risk numbers are slightly less than the risk of the acquirer because of the cash component of the deal.

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