Risk Arbitrage

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DEFINITION of 'Risk Arbitrage'

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.

INVESTOPEDIA EXPLAINS 'Risk Arbitrage'

In theory true arbitrage is riskless, however, the world in which we operate offers very few of these opportunities. Despite these forms of arbitrage being somewhat risky, they are still relatively low-risk trading strategies which money managers (mainly hedge fund managers) and retail investors alike can employ.

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RELATED FAQS
  1. How do I use the news to find arbitrage opportunities?

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  2. What happens to the stock prices of two companies involved in an acquisition?

    When a firm acquires another entity, there usually is a predictable short-term effect on the stock price of both companies. ... Read Full Answer >>
  3. What are the primary sources of market risk?

    Market risk is the risk of loss due to the factors that affect an entire market or asset class. Market risk is also known ... Read Full Answer >>
  4. How does beta measure a stock's market risk?

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  5. How does the risk of investing in the electronics sector compare to the broader market?

    The risk of investing in the electronics sector closely approximates the risk of investing in the broader market. The electronics ... Read Full Answer >>
  6. How much of a diversified portfolio should be invested in the electronics sector?

    The electronics sector tracks closely with the broader market, making it a cyclical sector with average volatility. Electronics ... Read Full Answer >>
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