Risk Arbitrage
The founding practitioner text on deal spread analysis.
Summary
Wyser-Pratte wrote this from his family's arbitrage business and from academic study, and it became the reference on risk arbitrage practice for a generation. It began as graduate work at New York University and was published as a short monograph.
The content covers the mechanics of the trade as practised before modern deal protection and disclosure rules. Wyser-Pratte defines risk arbitrage as taking positions in securities of companies subject to announced corporate events, distinguishing it from classical arbitrage in simultaneous offsetting positions. He covers the event types: cash tender offers, exchange offers, mergers, liquidations, recapitalisations and reorganisations, and for each explains what determines the payoff and what determines the probability of completion.
The analytical framework is expected value with explicit probability estimation. The arbitrageur estimates the gain if the deal completes, the loss if it breaks, which is generally the difference between the current price and the pre-announcement price, and the probability of completion, then sizes accordingly. Wyser-Pratte also develops the annualised return calculation given expected timing, which makes deals with different durations comparable, and covers the treatment of proration in partial tender offers.
The book is short and dated in its specifics. It predates the Williams Act's full effect, the modern hostile takeover era, the development of merger agreement deal protections, current antitrust practice and the electronic markets in which the strategy now operates. Wyser-Pratte himself moved to activism in later decades. Kirchner's Merger Arbitrage, also in this reference, covers the current practice. This remains worth reading as the original statement of the analytical framework, which has not changed.
Key takeaways 7
- Risk arbitrage means taking positions in securities subject to announced corporate events, which is distinct from simultaneous offsetting arbitrage.
- The trade is an expected value calculation combining the gain on completion, the loss on failure and the probability of each.
- The loss on a broken deal is approximately the return of the security to its pre-announcement price, which sets the downside.
- Annualising the expected return by the expected time to completion makes deals of different durations comparable.
- Partial tender offers require proration analysis, because the arbitrageur is left holding the untendered stub.
- Probability estimation rather than valuation is the arbitrageur's central skill.
- Position sizing must reflect the asymmetry, since one broken deal can eliminate the gains from many completed ones.
Who should read it
Event-driven investors who want the original statement of the arbitrage framework, supplemented by a modern text for current deal practice.
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