Wednesday, November 01, 2006

Arbitrage is intellectually stimulating...

In economics, arbitrage is the practice of taking advantage of a state of imbalance between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices.

In the stock market arbitrage comes in very many varieties -
a) Buyback Arbitrage
b) Delisting Arbitrage
c) Mutual Fund Arbitrage
d) Difference between BSE and NSE or other exchanges
e) Merger Arbitrage
f) Demerger Arbitrage
g) Litigation Arbitrage

That just about covers what I know of.

The best part about an arbitrage is that it pits you against intellectually superior people working in Hedge Funds and other investment houses. You are forced to raise your level of performance just to keep up with them.

You have to look at the same scenario as everybody else and come out with the best Highest reward - Lowest risk solution to the problem. In case, you are not able to, like poker, just walk away.

The need for this arises in sustained bull runs for most value oriented individuals/funds, when pickings are slim and the probability of buying anything cheap declines substantially. You have to be on the lookout all the time to avoid the "value traps" also.


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