concepts of international arbitrage

International arbitrage is the practice of profiting from price discrepancies between identical or similar financial instruments traded in different international markets. It exploits temporary inefficiencies in the global financial system. Here's a breakdown of the key concepts:  

Core Idea:

Price Discrepancies: Arbitrageurs identify situations where the same asset is trading at different prices in different markets.   This can occur due to factors like market inefficiencies, transaction costs, or information asymmetry.   Simultaneous Transactions: Arbitrage involves simultaneously buying the asset in the lower-priced market and selling it in the higher-priced market.   This locks in a risk-free profit.   Elimination of Discrepancies: As arbitrageurs exploit these price differences, they contribute to market efficiency by driving prices back into equilibrium.   Key Concepts:

Law of One Price: In an efficient market, identical assets should trade at the same price, regardless of location.   Arbitrageurs enforce this law by exploiting deviations.   Risk-Free Profit: Ideally, arbitrage transactions are risk-free, as the profit is locked in by simultaneous buying and selling.   However, in practice, there are risks associated with transaction costs, execution delays, and counterparty risk.   Transaction Costs: Arbitrageurs must consider transaction costs, such as brokerage fees and exchange fees, when evaluating potential opportunities.   The profit from arbitrage must exceed these costs to be worthwhile. Information Asymmetry: Arbitrage opportunities can arise due to differences in information availability across markets.   Arbitrageurs with access to superior information can gain an advantage. Interest Rate Parity: This concept relates to arbitrage in the forex market. It states that the interest rate differential between two countries should be equal to the difference between the forward and spot exchange rates.   Arbitrageurs exploit deviations from interest rate parity.   Purchasing Power Parity (PPP): This theory suggests that exchange rates should adjust to equalize the purchasing power of currencies in different countries.   Arbitrageurs can exploit deviations from PPP by trading goods or currencies.   Types of International Arbitrage:

Currency Arbitrage: Exploiting price differences in currency exchange rates across different forex markets. Interest Rate Arbitrage: Profiting from interest rate differentials between countries by borrowing in low-interest-rate countries and lending in high-interest-rate countries. Triangular Arbitrage: Exploiting price discrepancies between three currencies in the forex market.   Spatial Arbitrage: buying and selling the same asset in different geographical locations.   Covered Interest Arbitrage: Taking advantage of interest rate differentials between two countries while eliminating exchange rate risk through a forward contract. Challenges:

Execution Speed: Arbitrage opportunities are often short-lived, requiring rapid execution of trades.   Transaction Costs: Transaction costs can erode potential profits.   Regulatory Barriers: Different regulations across countries can create barriers to arbitrage.   Technological Requirements: High speed computers and data streams are required to perform modern arbitrage.   International arbitrage plays a crucial role in promoting market efficiency and price convergence in the global financial system