What is Arbitrage?
When similar or identical commodities and assets are simultaneously bought and sold on different markets at different prices in an effort to create profit. With advancements in technology, it can be difficult to profit from pricing differences in the market.
In financial and economic markets the term refers to a trade that attempts to create profit by capitalizing on the price differences of the same or similar items in different markets. It takes advantage of inefficient markets where the price of a good, service, or material (asset and commodity) doesn’t actually represent the true cost of the item. Arbitrage takes place when a commodity or asset is bought in one market while being sold concurrently in another market at an elevated price resulting in a profit for the seller.
Arbitrage can also be a regulatory force in markets by ensuring prices of goods, services, or materials do no diverge significantly from fair value for extended periods of time.
Arbitrage is possible when any one of three factors are at play:
- If identical or similar commodities and assets are not being traded at the same price on all markets.
- If Identical commodities and assets cash flows do not trade at the same price.
- If commodities or assets with a known future price do not currently trade at its future price discounted at the risk-free interest rate or the commodity or asset has large associated storage costs (this factor would hold for corn but not for stocks).
True arbitrage is not just the buying and selling of commodities and assets within markets. The process must take place concurrently to ensure the commodity isn’t exposed to market factors.
What people ask…
Is arbitrage illegal?
What is an example of arbitrage?
What causes arbitrage?
Do arbitrage opportunities exist?
See Also…
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