Financial Glossary: Arbitrage


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Arbitrage

Arbitrage

Arbitrage means dealing simultaneously in the same product in two markets to take advantage of temporary price distortions at minimal Risk. For example, a share with a Bid-Offer price of 100 - 101 in New York, and a Bid-Offer price of 102 - 103 in London, can be bought in New York at the Offer price of 101 and simultaneously sold in London at the Bid price of 102 - a Risk-free profit

In Economics and finance, Arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals is struck that capitalize upon the imbalance, the profit being the difference between the market prices.

When used by academics, an Arbitrage is a transaction that involves no negative Cash flow at any probabilistic or temporal state and a positive Cash flow in at least one state; in simple terms, a Risk-free profit. A person who engages in Arbitrage is called an arbitrageur. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives, commodities and currencies.

If the market prices do not allow for profitable Arbitrage, the prices are said to constitute an Arbitrage equilibrium or Arbitrage-free market. Arbitrage equilibrium is a precondition for a general economic equilibrium. The assumption that there is no Arbitrage is used in quantitative finance to calculate a unique Risk neutral price for derivatives.

Statistical arbitrage is an imbalance in expected nominal values. A casino has a Statistical arbitrage in almost every game of chance that it offers - referred to as the house edge or house advantage or even the Vigorish.

To profit through the buying and selling of the same asset without Risk, with no net outlay of capital. In reality, it requires the simultaneous buying and selling of the same asset and "earning" the difference.

Posted by IBC Conferences

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