Friday, April 24, 2015

arbitrage definition - any time before maturity

My understanding of the mathematical definition of arbitrage is vague. (I think in real financial world the precision may not be relevant.)

Here is one interesting point – if portfolio A and B have identical terminal value, then any time before maturity, they must always have equal market value, otherwise arbitrage exists. But what if (short) selling or is restricted or trading over a certain period is restricted?

In  real markets, many factors prevent arbitrage

* no bid or ask when you notice a mispricing
* insufficient quantity in the bid/ask. You may wipe it out then wait in vein.
* trading restrictions by authorities,
** short selling disallowed 
* most common factor - wide bid/ask spread, so you can't really make any money. I think this is the case in most securities including most options.

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