In business economics, finance and sports, arbitrage is the practice of taking advantage of a price difference between 2 or more markets: striking a mixture of matching deals that capitalize upon the imbalances, the profit being the gap relating to the market prices.
When used by academics, an arbitrage is often a transaction which involves no negative cashflow at any probabilistic or temporal state and also a positive income in at least one state; in simple terms, it’s the probability 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, this could refer to expected profit, though losses may arise, and in practice, there are always risks in arbitrage, some minor (such as fluctuation of prices decreasing income), some major (for instance devaluation of your currency or derivative).
In academic use, an arbitrage involves taking advantage of variations in cost of a single asset or identical cash-flows; in common use, it’s also utilized to reference differences between equivalent assets (relative value or convergence trades), for example merger arbitrage.
Individuals who take part in arbitrage are called arbitrageurs for example a bank or brokerage firm. The word is mainly related to trading in financial instruments, like bonds, shares, derivatives, products and currencies.
Sports arbitrage has also recently become possible due to the availability of online bookmakers offering widely diverging odds on sporting events producing situations where it’s possible to place bets that cannot lose.
Arbitrage is just not simply the act of purchasing a physical product in one market and selling it in another for a larger price at some later time. The deals must occur simultaneously to prevent exposure to market risk, or perhaps the risk that prices may change on one market before both deals are finished.
In functional terms, this can be generally only possible with securities and financial products which can be traded electronically, and even then, when each leg of the trade is executed the values sold in the market may have moved.
Missing one of the legs from the trade (and subsequently being forced to trade it soon after at a worse price) is known as ‘execution risk’ or more specifically ‘leg risk’.
“True” arbitrage mandates that there be no market risk included.