Evaluating Merger Arbitrage in European Equities: An Empirical Analysis of Merger Arbitrage Performance

Abstract

This thesis evaluates the performance of the merger arbitrage and the ability of the strategy to generate excess risk-adjusted returns in European equities in the period 1999 – 2018. The thesis evaluates a range of passive merger arbitrage portfolios consisting of cash, stock and hybrid consideration offers using a sample of 1,178 transactions consisting of mergers and acquisitions. The passive merger arbitrage strategy consists of investing in every available deal, this differs from an applied merger arbitrage strategy as funds typically select a small portfolio of deals with high estimated probabilities of success. The returns of the strategy are evaluated with the calendar time approach through a time-series analysis. The portfolios are subjected to three different kinds of weighting methods, equal and value weighted as well as applied portfolio weights mirroring restrictions typically seen in practice for the applied portfolio. We found that a merger arbitrage strategy consisting of cash deals, hybrid deals or all deals outperforms both a merger arbitrage index and the market with impressive Sharpe ratios ranging from 1.03 to 1.14 for equal weighted portfolios and 0.6 to 0.93 for value weighted portfolios, with the hybrid portfoliosrealizing the largest excess returns. Benchmarking the strategies of cash deals, hybrid deals or all deals to linear models revealed large, significant alphas for all equal weighted portfolios, ranging from annual abnormal returns of 8.03% to 19.62% and significant alphas for the value weighted portfolios ranging from 7.2% to 20.02%. The hybrid portfolios achieved the largest, significant alphas among all strategies, hence it is a very attractive portfolio, and should be an interesting subject for further studies. Surprisingly enough, all linear models showed a strong, significant correlation to excess market returns for the portfolios of cash deals, hybrid deals and all deals, even though existing literature suggests that the strategies should be market neutral. The majority of our portfolios did not find a nonlinear relationship between portfolio returns and excess market returns, and those that did were heavily influenced by outliers or missing deals to invest in.