3.17.2005

Q: If an instrument is priced rationally...

...should there be any arbitrage opportunity? If yes, how much investment does it require to turn that into a profit? If not, why not?

A: there should be no arbitrage opportunity according to the no-arbitrage principle. There is no free lunch in a well-functioning market. (And it takes 0 dollars to make an arbitrage profit.)

Long Answer: Arbitrage is a a process through which an investor (aka arbitrageur) can buy an asset or combination of assets at one price and concurrently sell at a higher price, thereby earning a profit without investing any money or being exposed to any risk. The no-arbitrage principle

  • facilitates the determination of prices: the combined actions of many investors engaging in arbitrage result in rapid price adjustments that eliminate any arbitrage opportunities, thereby bringing prices back.
  • promotes market efficiency: quickly eliminate arbitrage opportunities available in the market

Category: C++ Quant > Derivatives > Valuation

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