An arbitrageur is a trader who exploits pricing inconsistencies across markets, contracts, or closely related assets.
Economic role
Arbitrageurs do more than make money for themselves. They help markets discover coherent prices. By buying underpriced assets and selling overpriced ones, they narrow price gaps and improve the consistency of market valuations.
Why arbitrageurs matter
Many finance models assume mispricing will be corrected quickly. In practice, that correction depends on actual arbitrageurs having the capital, information, and risk tolerance needed to take the other side of the trade.
Limits to arbitrage
Arbitrageurs are constrained by:
- funding and collateral requirements,
- short-selling rules,
- model uncertainty,
- the risk that mispricing widens before it closes.
Those limits explain why apparent valuation errors can survive longer than simple theory predicts.
Related Terms
Knowledge Check
### What is the main function of an arbitrageur?
- [x] To exploit and help close pricing inconsistencies
- [ ] To set monetary policy
- [ ] To audit company accounts
- [ ] To determine tax rates
> **Explanation:** Arbitrageurs trade against price gaps and help move markets toward more consistent valuations.
### Why might an arbitrageur fail to eliminate a mispricing immediately?
- [x] Because capital, short-selling, or risk constraints can block the trade
- [ ] Because arbitrage never affects prices
- [ ] Because equivalent assets do not exist in markets
- [ ] Because transaction costs are always zero
> **Explanation:** Limits to arbitrage are a major reason why some pricing anomalies persist.
### An arbitrageur improves market function mainly by:
- [x] contributing to price discovery and consistency
- [ ] guaranteeing equal returns for everyone
- [ ] removing uncertainty from the economy
- [ ] preventing all speculation
> **Explanation:** Arbitrage activity helps align prices with comparable payoffs.