Merger Arbitrage in Europe: An Empirical Analysis

Aadne Ellingsberg & Johan Jakob Lothe

Student thesis: Master thesis


The purpose of this thesis is to assess the performance of a merger arbitrage investment strategy. Merger arbitrage involves investing in equity in merger or acquisition deals to capture the arbitrage spread. Previous research has found that merger arbitrage generates significant abnormal returns over long time periods. However, much of the research is outdated and mainly based on data from the United States. Thus, this thesis seeks to study the performance of the merger arbitrage investment strategy in Europe, with a more recent sample from 1997 to 2019.
The performance of the strategy is tested by generating returns from portfolios of cash deals, stock deals, combination deals and all deal types. Three different portfolio types are created: an equal­weighted, a value-weighted and a merger arbitrage index manager portfolio, which includes several practical restrictions and transaction costs. Furthermore, the performance of the portfolios is assessed using common performance measures. The abnormal returns of each portfolio are investigated using the CAPM, Fama-French three-factor and five-factor models, and a momentum factor. Additionally, a contingent claims analysis is conducted where a nonlinear relationship is found. Lastly, the results of the analysis are validated through several robustness tests.
The analysis shows that the merger arbitrage investment strategy generates returns substantially higher than both the market portfolio and two merger arbitrage indices over the period studied. Furthermore, the strategy also generates significant abnormal returns after controlling for known risk factors. However, including practical limitations and transaction costs greatly reduces the abnormal returns, though the strategy still provides significant abnormal returns in low transaction cost environments. Furthermore, deals including small target firms tend to outperform deals including larger target firms. It is also found attractive for investors to diversify across all deal types. Moreover, a long-term perspective would leave investors less exposed to currency risk. Finally, the results indicate that Western Europe and the British Islands are more profitable than other regions, while the Nordics are less profitable.
The level of abnormal returns found for Europe somewhat deviate from what previous research found for other markets. However, this can to a great extent be explained by differences in regulations that reduce the withdrawal and financing risk, differences in the time period studied, sample sizes and payment methods. Moreover, the finding of a nonlinear relationship is less economically important in Europe than what previous research conclude for the United States.

EducationsMSc in Finance and Accounting, (Graduate Programme) Final ThesisMSc in Finance and Investments, (Graduate Programme) Final Thesis
Publication date2020
Number of pages189