I wasn’t aware of this concept until now, but now that I’ve seen it it’s quite obvious. Whenever a merger is announced, the share price should rise to the acquisition share price. But that discards two types of risk compensation:
- The time value of money: the spread should close at the moment the shares are actually purchased
- The risk that the deal may fall through
The second one seems to be very prominent last week with Nvidia announcing it will no longer be pursuing an acquisition of Arm.
Hedge funds can bet on these risks and achieve substantial returns.