In business economics, finance and sports, arbitrage is the technique of taking advantage of a cost difference between 2 or more markets: striking a mixture of matching deals that capitalize upon the imbalances, the gain being the difference within the market prices.
When utilized by academics, an arbitrage can be described as transaction that concerns no bad cashflow at any probabilistic or temporal state along with a positive cashflow in one or more state; essentially, it is the chance of a risk-free profit at zero cost.
In principle and in academic use, an arbitrage is risk-free; in common use, for example statistical arbitrage, it may well relate to projected profit, though losses may arise, and in practice, there are always risks in arbitrage, some minor (for instance fluctuation of prices decreasing income), some major (for example devaluation of a currency or derivative).
In academic use, an arbitrage involves taking advantage of variations in price of a single asset or identical cash-flows; in common use, it’s also utilized to mean differences between very similar assets (relative value or convergence trades), as in merger arbitrage.
Individuals that participate in arbitrage are known as arbitrageurs say for example a bank or brokerage firm. The phrase is principally related to trading in financial instruments, such as bonds, shares, derivatives, products and currencies.
Sports arbitrage has additionally recently become practical mainly because of the use of world-wide-web bookmakers offering widely diverging odds on sports establishing situations where you’ll be able to where you can’t lose
Despite the fact that this involves bookmakers it is not gambling as there is no risk to the initial stake which can’t be lost. These betting systems or betting strategies are called ‘Arbitrage Betting’ or ‘Matched Betting’
Arbitrage is not simply the act of purchasing a physical product in one market and selling it in another for a higher price at some later time. The deals must transpire simultaneously to prevent exposure to market risk, or even the risk that prices may change in one market before both dealings are complete.
In functional terms, this is generally only possible with securities and financial products that may be traded electronically, and even then, when each leg of your trade is completed the prices on the market might have moved.
Missing one of the legs of the trade (and subsequently having to trade it immediately after at a worse price) is known as ‘execution risk’ or more specifically ‘leg risk’.
“True” arbitrage mandates that there be no market risk involved.