The No Arbitrage Condition is a fundamental principle in financial economics that ensures there are no opportunities to make a risk-free profit without any investment. It underpins the pricing of financial instruments by asserting that equivalent assets or portfolios must have the same price to prevent arbitrage opportunities.

No Arbitrage Condition

fundamental principle

financial economics

Risk-free profit refers to the theoretical return on an investment with zero risk, often associated with government bonds in stable economies. It is crucial for financial models as a benchmark to evaluate the performance of risky investments and to calculate the risk premium.

risk-free profit

Investment involves committing resources, typically money, to an endeavor with the expectation of generating a profit or income over time. It requires evaluating risk and potential return, and can be influenced by factors such as market conditions, economic trends, and individual financial goals.

investment

pricing of financial instruments

equivalent assets

portfolios

same price

Arbitrage opportunities arise when there is a price discrepancy for the same asset in different markets, allowing traders to buy low in one market and sell high in another for a risk-free profit. These opportunities are typically short-lived as the actions of arbitrageurs help to restore price equilibrium across markets.

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