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Arbitrage

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Abstract

An arbitrage opportunity is an investment strategy that gurantees a positive payoff in some contingency with no possibility of a negative payoff and with no net investment. By assumption, it is possible to run the arbitrage possibility at arbitrary scale; in other words, an arbitrage opportunity represents a money pump. A simple example of arbitrage is the opportunity to borrow and lend costlessly at two different fixed rates of interest. Such a disparity between the two rates cannot persist: arbitrageurs will drive the rate together.

Keywords

  • Asset Price
  • Option Price
  • Risk Premium
  • Capital Structure
  • Martingale Measure

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© 1989 Palgrave Macmillan, a division of Macmillan Publishers Limited

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Dybvig, P.H., Ross, S.A. (1989). Arbitrage. In: Eatwell, J., Milgate, M., Newman, P. (eds) Finance. The New Palgrave. Palgrave Macmillan, London. https://doi.org/10.1007/978-1-349-20213-3_4

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