Risk Arbitrage

Risk arbitrage, or risk arb is usually taken to mean trading in stocks possibly involved in a merger or acquisition. More clearly, this risk arbitrage strategy is sometimes called merger arbitrage. The premise of this type risk arbitrage is that an acquiring company will usually make a tender offer for all outstanding shares at a premium above the current market price. Buying shares speculatively on the basis of a rumor of a tender offer and after the offer has been announced are each considered risk arbitrage. Since shares of the acquiring company tend to fall, selling its shares short is often part of the risk arbitrage strategy, too. Entire books have been written about risk arbitrage situations including the merger event and other special situations. While originally mostly the domain of the hedge fund, today risk arbitrage trading approaches are available to the individual investor. Risk arbitrage is a slight misnomer since in theory arbitrage is risk free, but in practice there is some risk to any risk arbitrage trading strategy.