No-arbitrage principle

Definition

No-arbitrage principle in plain English

There's a bedrock rule in finance: if two things are guaranteed to pay you exactly the same amounts in the future, they must cost the same today. If they didn't, you'd buy the cheap one, sell the expensive one, and pocket the difference for free with zero risk — a "free lunch," which the word arbitrage means. Because armies of traders instantly hunt down and erase any such gap, we assume it's already gone, and that single assumption is enough to pin down the fair price of almost everything else in finance. It's the finance version of "two identical candy bars at the same store can't have different price tags for long."

Related Quantitative Finance terms

• Cointegration
• Limit order book
• Price impact
• Stationarity
• Ornstein-Uhlenbeck process
• Autocorrelation
• Bayes' theorem
• Efficient frontier