Arbitrage

The exploitation of prices differences in connected markets. Most frequent used to indicate the simultaneous purchase and sale on different markets of the same or equivalent financial instruments to profit from price or currency differentials. The exchange rate differential may be derived from deposit rate differentials or swap points. If instruments that have identical characteristics do not trade at the same price, a risk-free profit can be generated by simultaneously selling the higher-priced asset and buying the lower priced asset. True arbitrage is the identification and exploitation of such price anomalies. More generally the term arbitrage is used to mean profiting from differences in price between similar securities or from trades which are undertaken when prices have moved from some historical or theoretical path or relationship in the expectation of a move back to the statistical norm. This is also known as statistical arbitrage. Arbitrage opportunities are often precluded because of transactions costs.