Pricing and Hedging Financial Derivatives in Merger\&Acquisition Deals with Price Impact

2026-04-23

AI Summary

This study addresses the optimal execution and fair pricing of financial derivatives—including total return swaps, collar options, and TWAP Asian contracts—in merger and acquisition transactions under price impact. Employing the principle of utility indifference alongside stochastic control and a linear market impact model, the paper derives optimal execution strategies and equitable fees for both cash-settled and physically delivered contracts. Its key contribution lies in demonstrating that linear cash-settled contracts are particularly vulnerable to market manipulation and statistical arbitrage, while also providing the first systematic quantification of the sensitivity of nonlinear and Asian-style contracts to such risks. These findings offer a theoretical foundation for the design and regulation of complex derivatives in markets with liquidity frictions.

Technology Category

• Game Theory and Economic Paradigms: Fair Division
• Multiagent Systems: Mechanism Design
• Search and Optimization: Non-convex Optimization

Application Category

• Economics, Online Markets and Human Computation: Fairness, privacy, and diversity in economic environments
• Security and Privacy: Data transparency and provenance
• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs

Abstract

We investigate the optimal execution of contracts that are used in merger\&acquisition deals. We consider cash-settled and physically delivered contracts between a broker and a counterpart. Contracts are linear (total returns swaps), nonlinear (collar contracts) or Asian type (TWAP based contracts). We derive the optimal execution strategy and the optimal fee through indifference utility arguments allowing for linear market effects of trades. We show that linear cash-settled contracts are more expensive and more exposed to manipulation/statistical arbitrages by the broker. Also nonlinear and Asian type contracts are exposed to these phenomena.

Problem

• Pricing
• Hedging
• Financial Derivatives
• Merger & Acquisition
• Price Impact

Innovation

• price impact
• optimal execution
• indifference utility
• merger and acquisition derivatives
• market manipulation