What Does Risk Arbitrage Mean?
A broad definition for three types of arbitrage that contain an element of risk: 1) Merger and acquisition arbitrage – The simultaneous purchase of stock in a company being acquired and the sale (or short sale) of stock in the acquiring company. 2) Liquidation arbitrage – The exploitation of a difference between a company’s current value and its estimated liquidation value. 3) Pairs trading – The exploitation of a difference between two very similar companies in the same industry that have historically been highly correlated. When the two company’s values diverge to a historically high level you can take an offsetting position in each (e.g. go long in one and short the other) because, as history has shown, they will inevitable come to be similarly valued.
