Hi Im working on an assignment for my international banking/finance.
The question is why don’t arbitrage opportunities exist for long periods of time?
If anyone knows it, help me.
Arbitrage occurs when the price of one financial instrument is different in more than one location. This can happen frequently in cases where stocks trade in multiple countries. For example British Petroleum shares might be selling for 71 lbs on the London Exchange, but only for the equivalent of 70.80 lbs on the New York Stock Exchange. A really savy trader will notice this discrepancy, buy the shares off of the New York Stock Exchange and then sell them on the London exchange for a quick profit. When they purchase the shares on the NYSE that causes the price on the NYSE to go up, when they sell on the London exchange that causes the price there to go down, so the result is that the price of BP on the NYSE and the London exchange equal out.
Since we live in such a high tech age with computers and whatnot, arbitrage is even more efficient. Computers at brokerage companies will constantly scan the market for arbitrage opportunities and as soon as they find them, will instantly make the trades for the quick profit. This has made the time window of opportunity for arbitrage extremely short.
There is one exception of arbitrage that is available for quite some time. This is Merger and Acquisition arbitrage. When a company offers to buy another one out the buying company will declare a price that they want to pay for the other company (say its $10 per share). Shares in the company being bought will almost always instantaneously jump to about $9.80 or somewhere shy of $10. The theory is that the market is not 100% sure about when or if the acquisition will actually take place. It is an arbitrage opportunity though in that you can buy the shares for $9.80 and eventually have them bought from you by the buying company for $10. This window of opportunity may be open for months at a time though until a final decision is made, all the paperwork is done, and you receive the money for your shares.
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