Competition Scale and Hedge Fund Performance: Evidence from Merger Arbitrage

Journal of Economics and Business, No. 105, 2019

In a paper published in the Journal of Economics and Business, Managing Principal Gaurav Jetley and his coauthor, Professor Zaur Rzakhanov of the University of Massachusetts, Boston, contribute new insights to the academic literature on the effect of scale on performance of active money management.

In “Competition scale and hedge fund performance: Evidence from merger arbitrage,” the two authors introduce a novel, single-variable measure for sector size in merger arbitrage that they call MACA, or merger arbitrage capital abundance. They use this ratio of capital supply to demand for capital to develop a model for analyzing arbitrage spread and isolating the effect of competition among arbitrageurs on stock prices and, consequently, hedge fund alpha (profitability). The authors also determine that between 16 and 18 basis points of alpha per month can be attributed to managers’ individual skill levels, independent of other factors such as prevailing economic conditions or length of managerial experience.

The authors believe that their model is the first to account for the impact of both supply of, and demand for, capital in analyzing diseconomies of scale in hedge fund performance. As their findings illustrate, greater competition among arbitrageurs reduces the difference between bid price and the target’s market price in an acquisition, thus reducing arbitrageurs’ compensation for assuming deal risk and providing liquidity to target shareholders.

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Jetley G; Rzakhanov Z