Handbook of Alternative Assets Ch 6 - Fund Return Distributions

Question 1

Explain why the return distribution of corporate restructuring hedge funds mirrors that
of a put option

Answer 1

If the underlying event (i.e. a merger and acquisition) succeeds, then the hedge
fund manager will earn steady positive returns

However, if the underlying event fails (i.e. the deal gets called off), then the hedge
fund manager can experience massive losses from the price of the securities not
converging the way the trading strategy expected it to

Thus, the return distribution will likely have a fat negative tail (i.e. negative skew)