TL;DR
This paper discusses arbitrage strategies in financial markets, emphasizing their theoretical implications and the importance of market equilibrium in preventing riskless profit opportunities.
Contribution
It analyzes the fundamental role of arbitrage constraints in establishing key financial models like option pricing and hedging in complete markets.
Findings
Arbitrage opportunities are disallowed in equilibrium markets.
Arbitrage constraints underpin option-pricing formulas.
Market equilibrium prevents riskless profit opportunities.
Abstract
An arbitrage strategy allows a financial agent to make certain profit out of nothing, i.e., out of zero initial investment. This has to be disallowed on economic basis if the market is in equilibrium state, as opportunities for riskless profit would result in an instantaneous movement of prices of certain financial instruments. The principle of not allowing for arbitrage opportunities in financial markets has far-reaching consequences, most notably the option-pricing and hedging formulas in complete markets.
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Taxonomy
TopicsBusiness Strategy and Innovation