SMABS 2004 Jena University
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European Association of Methodology

Department of methodology and evaluation research

Jena University

Contributions: Abstract

Price convergence of target stock by mergers and acquisitions under uncertainty of the deal completion.

Sergey Gelman
University of M√ľnster
Germany

The probability implicitly attached by the market to the successful takeover conclusion is an important issue for many decision-making parties (bidder, target, small investors, etc.). It has obviously great influence on the price dynamics of target stock. However, the takeover probability is not directly observable.

This paper analyses the impact of the takeover probability on the price dynamics of target stock based on a (continuous-time) time-contingent regime switching model developed in recent literature on the currency conversion (after modifying for stock). The analysis yields that the higher value of the takeover probability leads to quicker convergence of the target stock price towards the bid offer price and by cash bids to lower instantaneous variance of the target price.

Changes in the takeover probability are found to have greater impact on the target stock price if the time point of changes lies closer to the anticipated takeover date, if the fundamental value of target stock is further away from the bid offer price, and if the discount factor is lower. Variability of changes in the takeover probability raises the instantaneous variance of the target stock price proportionally to the squared discounted difference between the bid offer price and the fundamental value of target stock.

For the empirical estimation of the takeover probability, the paper proposes to estimate at first the parameters of the fundamental process on the time window preceding the beginning of the anticipation of takeover in order to forecast the fundamental process into the observation window. The takeover probabilities are then estimated with the help of Kalman filtering using as data the target price dynamics in the observation window, adjusted for the effects of time, of bidder stock price (by share bids), and of the fundamental value.