Risk arbitrage

Risk arbitrage is an investment or trading strategy often associated with hedge funds.

It's also called merger arbitrage, which is a more straightforwardly descriptive name. When one corporation announces plans to merge with or acquire another, stock traders know that the merger, if consummated, will have predictable consequences for the stock prices of both entities. Typically the acquirer will announce the stock price its prepared to pay for its target, and that price will be at a premium above the pre-announcement market price. An arbitrageur will then short sell the acquirer and buy the stock of the target, in the expectation that the former will decline and the latter will rise.

If that were all there was to it, then everyone would do it immediately, and any possible gain would disappear very quickly. But there is more to it, the risk that the deal won't go through, because of opposition from the target company's board members, or antitrust or regulatory authorities, or a change of heart on the part of the acquirer's board, or for any other cause. Such possibilities put the risk in the term risk arbitrage.

When hedge fund strategies are sorted into categories, risk arbitrage is sometimes included with other forms of arbitrage. But it can also be included as one among the event driven strategies.