Arbitrage Advantages and Disadvantages

Vinish Parikh December 7, 2012

Arbitrage is strategy in finance with the help of which an individual can make risk-less profit by taking advantage of price difference between the two markets of same security. Given below are some of the advantages and disadvantages of arbitrage –

Arbitrage Advantages

  1. The biggest benefit of doing arbitrage is that the risk element is next to nil, it can better understood with the help of an example, if a multinational company is listed in stock markets of New York and London and in New York market it trade at $100 and in London market it trades at € 160 and exchange rate is $1 = €2 than ideally it should trade in London markets at €200. Now a person thinking of doing arbitrage would sell stock in New York market and buy the same stock in London market and thus he or she would be able to make risk-less profit.
  2. Arbitrage helps in keeping the price of securities across the markets more or less same and therefore it help in better price discovery of an asset and also put an end to price variances in securities across various markets.
  3. It helps in making the financial markets more efficient because imagine if there were no arbitrageurs than stocks would have kept trading at different prices in different markets leading to speculation by few individuals which would have damaged the real investors’ confidence in stock market.

Arbitrage Disadvantages

  1. Many individuals only into take into account the price aspect and they ignore the transactions costs and taxes associated with buying and selling of asset which in turn results in wrong estimation of profits and may even lead to loss if price difference is not much.
  2. In real life there are not many arbitrage opportunities and even if there are then in order to make profit put of such situations you need to have latest technology in order to take positions quickly and also expertise to make such transactions which only few people possess.
  3. One requires lot of money in order to do arbitrage, it is not as if you have $2000 then you can do it rather one need to have much more money in order to do a profitable arbitrage.