the day. The constant arrival of information assumption is probably not cor-
rect under such circumstances.
SUMMARY
The spread observed in the marketplace between two companies in-
volved in a merger is likely to be distorted due to other market effects
like the bid-ask spread effects and market maker inventory adjustments.
The Kalman filtering approach is a suitable smoothing technique for es-
timating the actual spread levels.
The filtered spread could be used for the risk-neutral probability and
also assist in timing executions.FURTHER READING MATERIAL
Kalman Filter
Harvey, A. C. Time Series Models, 2ndEdition. (Cambridge, Mass: MIT Press, 1993),
pp. 82–104.
Model Choice
Kalaba, R., and T. Tesfatsion. “A Multicriteria Approach to Model Specification and
Estimation.”Computational Statistics and Data Analysis21 (1996): 193–214.
Realized Volatility
Anderson, T. G., and others. “The Distribution of Exchange Rate Volatility.” Sym-
posia 99, Statistical Issues in Risk Management. Leonard N. Stern School of
Business, April 1999.
Spread Inversion 199