Monday, 25 June 2012

Arbitrage Definition

Arbitrage Definition

      Arbitrage is also referred to as 'Arb'. It is the activity or process of taking advantage / exploiting a price difference on the same or simlar products but on different markets. One example could be arbitrage of an interlisted stock - buying it on one exchange and selling it on another where there is a price difference and opportunity to make a profit. 

      In theory true arbitrage is considered risk free although in reality - like most investments there is usually some element of risk. It is very hard for the retail investor to identify opportunities for good arbitrage as it requires very quick and effective trade execution and more importantly deep analysis. Typically large institutions will be able to exploit Arb opportunities better than the public as their technical expertise and resources of larger capital pools give them an edge on these opportunities. 

     Arbitrage activity is significant as it ensures prices and markets operate more efficiently. If there are discrepencies between prices on similar financial instruments across markets they are typically identified quickly and arbitrage opportunists will 'push' prices back in line.


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