Arbitrage is buying an asset in one market and simultaneously selling an identical asset in another market at a higher price. Sometimes these will be identical assets in different markets, for instance, shares in a company listed on both the London Stock Exchange and New York Stock Exchange. Often the assets being arbitraged will be identical in a more complicated way, for example, they will be different sorts of financial securities that are each exposed to identical risks.
Some kinds of arbitrage are completely risk-free—this is pure arbitrage. For instance, if Euros are available more cheaply in dollars in London than in New York, arbitrageurs (also known as arbs) can make a risk-free profit by buying Euros in London and selling an identical amount of them in New York. Opportunities for pure arbitrage have become rare in recent years, partly because of the globalization of financial markets. Today, a lot of so-called arbitrage, much of it done by hedge funds, involves assets that have some similarities but are not identical. This is not pure arbitrage and can be far from risk free.
- Copied from: Economist.com Economics A-Z