The DCP is a figure calculated and assigned to the probability of a merger & acquisition deal being successfully completed. Merger Arbitrage Limited uses the data given in our spread list spreadsheet as a starting point for making this calculation. We frequently refer to this number in numerous articles throughout the website as a way describing the effect a particular piece of information can have on the movement of the merger arbitrage spread. For more information see Deal Closing Probability, or “Why Merger Arbitrage involves more risk than you might think“.
A figure of less than 100% implies a spread is available as there is a less than perfect chance that the deal will consummate as expected. A figure in excess of 100% implies the market anticipates a higher offer. This can in turn be built into the model and the DCP recalculated with the possibility of a higher or competing offer. By increasing the potential payout from a successful takeover, the trader ensures the DCP figure remains with a 0% – 100% range.
Using the DCP
If the trader calculates the probability of the deal closing equates to the current market price a position should not be initiated as there is no “edge”, or alpha in the trade. Alternatively speaking, there is no arbitrage in the Merger Arbitrage.
This figure can be contrasted with Deal Failure Probability (DFP). It is simply the result of subtracting either of the statistics from 1. Hostile takeovers therefore will naturally have a lower DCP as the chance of these deals being successfully consummated is reduced without the blessing of management and the board of directors.
