In business economics, finance and sports, arbitrage is the concept of taking benefit from a price difference between two or more markets: striking a mix of matching trades that take advantage upon the discrepancy, the profit being the gap within market prices.
When used by academics, an arbitrage is often a transaction that involves no negative cashflow at any probabilistic or temporal state and also a positive cash flow in at least one state; basically, it’s the potential for a risk-free gain at zero cost. In effect free money from trades where zero risk existed.
In commercial markets this is called ‘Arbitrage’. In gambling markets it is called Matched Betting.
In principle as well as in academic use, an arbitrage is risk-free; in common use, for example statistical arbitrage, it may well make reference to predicted profit, though losses may manifest, and in practice, there are always risks in arbitrage, some minor (including fluctuation of prices decreasing income), some major (along the lines of devaluation of the currency or derivative).
In academic use, an arbitrage involves benefiting from variations in price of a single asset or identical cash-flows; in common use, it is usually employed to focus on differences between equivalent assets (relative value or convergence trades), for example merger arbitrage.
People who engage in arbitrage are called arbitrageurs perhaps a bank or brokerage firm. The word is mainly related to trading in financial instruments, which include bonds, stocks and shares, derivatives, products and currencies.
Specific sport arbitrage has additionally recently become achievable because of the use of online bookmakers offering widely diverging odds on sports creating situations where it is possible to place bets that cannot lose.
Although this involves bookmakers it isn’t gambling as there isn’t any risk on the initial stake which can’t be lost.
Arbitrage isn’t simply the act of buying a product in one market and selling it in another for a higher price at some later time. The dealings must transpire simultaneously to prevent exposure to market risk, or perhaps the risk that prices may change in one market before both trades are completed.
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 carried out the values in the market may have moved.
Missing one of the legs of the trade (and subsequently having to trade it soon after at a worse price) is called ‘execution risk’ or more specifically ‘leg risk’.
“True” arbitrage mandates that there be no market risk included.
