In business economics, investment and sports, arbitrage is the concept of taking benefit from a price difference between 2 or more markets: striking a mix of matching deals that capitalize upon the discrepancy, the gain being the differences relating to the market prices.
When used by academics, an arbitrage can be described as transaction which involves no damaging cashflow at any probabilistic or temporal state along with a positive cash flow in one or more state; essentially, it’s the probability of a risk-free profit at zero cost.
In principle and in academic use, an arbitrage is risk-free; in common use, for example statistical arbitrage, it may well mean anticipated profit, though losses may happen, and in practice, there are always risks in arbitrage, some minor (such as change of prices decreasing profit margins), some major (including devaluation of a currency or derivative).
In academic use, an arbitrage involves benefiting from differences in cost of a single asset or identical cash-flows; in common use, it is also used to focus on differences between very similar assets (relative value or convergence trades), such as merger arbitrage.
Individuals who practice arbitrage are known as arbitrageurs perhaps a bank or brokerage firm. The word is principally ascribed to trading in financial instruments, which include bonds, futures, derivatives, goods and currencies.
Sports arbitrage has additionally recently become possible mainly because of the availability of world-wide-web bookmakers offering widely diverging odds on sports creating situations where it’s possible to where you can’t lose
Even though this involves bookmakers it is not gambling as there isn’t any risk to the initial stake which cannot be lost. These betting systems or betting strategies are called ‘Arbitrage Betting’ or ‘Matched Betting’
Arbitrage isn’t simply the act of purchasing a product in one market and selling it in another for a better price at some later time. The deals must transpire simultaneously to avoid exposure to market risk, or perhaps the risk that prices may change on one market before both deals are completed.
In practical terms, this can be generally only possible with securities and financial products which may be traded electronically, and even then, when each leg of your trade is completed the values in the market could have moved.
Missing one of the legs of the trade (and subsequently having to trade it immediately after at a worse price) is called ‘execution risk’ or more specifically ‘leg risk’.
“True” arbitrage mandates that there be no market risk concerned.
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