The Shrinking Merger Arbitrage Spread : Reasons and Implications

In this study, we examine the evolution of the arbitrage spread between 1990 and 2007 and find that since 2002 the arbitrage spread has declined by over 400 basis points (quot;bpsquot;). This decline is both economically and statistically significant. The decline in arbitrage spread corresponds with the decline in aggregate returns of Mamp;A hedge funds as well as increased inflows into Mamp;A hedge funds. We explore three possible explanations for the decline in arbitrage spread. Our study finds that a part of the decline in arbitrage spread may be explained by increased trading in the targets' stock subsequent to the merger announcement, reduced transaction costs, and changes in risk related to merger arbitrage. Our findings suggest some of the decline in arbitrage spread is likely to be permanent and thus investors seeking to invest in Mamp;A hedge funds should focus on returns of the prospective funds since 2002 rather than returns over a longer period of time