Finance Dictionary
Arbitrage
Definition
The simultaneous purchase and sale of an asset to profit from an imbalance in the price.
Deep Dive
Arbitrage is the simultaneous purchase and sale of an asset in different markets to profit from a temporary difference in its price. The core principle involves exploiting discrepancies in pricing for the exact same asset or for closely related assets that are functionally equivalent. For true arbitrage, the transaction must be risk-free, meaning the profit is guaranteed because the trades are executed almost instantaneously, eliminating market exposure between the buy and sell orders.
Examples & Use Cases
- 1A trader notices that a particular stock is trading for $50 on the New York Stock Exchange and simultaneously for $50.05 on the London Stock Exchange (after currency conversion). The trader buys shares on the NYSE and immediately sells them on the LSE to capture the $0.05 profit per share.
- 2A foreign exchange trader identifies a pricing inconsistency between three currencies (e.g., buying USD with EUR, then JPY with USD, then EUR with JPY) that results in a net profit after all conversions. This is known as triangular arbitrage.
Related Terms
Market EfficiencyHigh-Frequency TradingSpreadHedgingSpeculation