In business economics, finance and sports, arbitrage is the practice of taking benefit from a cost difference between several markets: striking a combination of matching deals that capitalize upon the imbalances, the gain being the difference within market prices.
When utilized by academics, an arbitrage is actually a transaction which involves no bad cash flow at any probabilistic or temporal state as well as a positive cash flow in one or more state; basically, it’s the possibility of a risk-free profit at zero cost.
In principle and within academic use, an arbitrage is risk-free; in common use, for example statistical arbitrage, it may well reference expected profit, though losses may happen, and in practice, there are always risks in arbitrage, some minor (which include fluctuation of prices decreasing profit margins), some major (including devaluation of your currency or derivative).
In academic use, an arbitrage involves taking advantage of differences in cost of a single asset or identical cash-flows; in common use, it might be employed to make reference to differences between very similar assets (relative value or convergence trades), as in merger arbitrage.
People who practice arbitrage are known as arbitrageurs say for example a bank or brokerage firm. The word is primarily given to trading in financial instruments, for instance bonds, stocks and shares, derivatives, goods and currencies.
Sports arbitrage has also recently become possible due to the availability of web-based bookmakers supplying widely diverging odds on sports creating situations where it is possible to place bets that cannot lose.
Even though this involves bookmakers this isn’t gambling as there’s no risk on the initial stake which can’t be lost. This is whats called ‘Arbitrage Betting‘ or ‘Matched Betting‘
Arbitrage is not simply the act of purchasing an item in one market and selling it in another for a better price at some later time. The deals must occur simultaneously in order to avoid exposure to market risk, or maybe the risk that prices may change in one market before both trades are completed.
In simple terms, this can be generally only possible with securities and financial products which can be traded electronically, and even then, when each leg of the trade is accomplished the prices on the market could have moved.
Missing one of the legs from the trade (and subsequently being forced to trade it immediately after at a worse price) is called ‘execution risk’ or more specifically ‘leg risk’.
“True” arbitrage requires that there be no market risk involved.