Question

Explain in word what “no arbitrage” condition mean and why this condition may not hold true in reality? Bring at least 2 reasons for it.

Answer 1

Arbitrage is the kind of security that is buying from one market and selling another market at a higher price. Arbitrage is a risk-free aspect.

No-arbitrage bounds mean there is a limit on financial portfolio prices. It’s considering a situation where all assets are risk-free and no one can outpace market gains without taking the risk.

But it is only based on theoretical, not in real life. This is because any product in the cheap market will push up the price and make an expensive product until it reaches equilibrium. Arbitrage means there are zero risks but it is not possible because in trade there is a minimum risk which is near to zero but not zero.