Pros and Cons of Arbitrage

The Act of arbitrage is only that of trading in the asset with no gain in the knowledge in the mispricing of the costs; the transportation, storage and other costs being included by the arbitrageur calculation. The pecuniary attractiveness in the opportunities is quick which lose their sheen if not acted upon, as they are termed to be out of the market and marginal holdings of the buyer cannot be arbitraged further.

While profits are earned in this way of trading, there is another side of losing it all out which us impending which is evident if an arbitrage opportunity is lost, with the expectation of gaining in the future, which again could be an uncertain loss. Thus since the window opportunity could be very short one has to act promptly else the situation will be speculative.

Pros

  • the arbitrageur has to acknowledge the risk associated which could be almost nil, with the arbitrage and losing out on the opportunity as every transaction is timed and then it just disappears without a chance to wait and re-trade
  • it helps in pricing the securities across the markets more or less and thus negate the pricing variances as a better price is discovered with every strategy used with an end to all pricing variances in various markets
  • The financial markets become more efficient as if there were no arbitration selling then the stocks would be sold and bought at different pricing in different markets with speculation done by few individuals who otherwise would have destroyed investor’s confidence in the trading stock markets.

Cons

  • there is more than the pricing cost in the arbitrage transactions, there is no such consideration for the taxes, transactional costs in the buying and selling of the assets, hence there is an incorrect estimation on the profits and thus could reduce the pricing differentiation
  • since arbitrage opportunities are not many lots of innovative technology has to be used to get the correct exposure quickly and trade effectively which has to be done only if one has expertise in the field
  • The amount of money involved in arbitrage is huge and thus refrains many to get into such risk minimizing solutions and make a profitable arbitrageur.

Since everything depends on how successful the strategy is, taking advantage of the price difference between two different markets, the risk is reduced to a great extent on the similar trading securities.