What is the concept of "arbitrage" in finance?

The concept of "arbitrage" in finance refers specifically to the practice of taking advantage of price differences in different markets. When an asset is priced differently in two or more markets, an arbitrageur can buy the asset in the market where it is cheaper and sell it in the market where it is more expensive, generating a risk-free profit. This typically occurs in highly liquid markets where the inefficiencies can be exploited quickly before they disappear, ensuring that the pricing across markets comes into equilibrium.

This activity is essential for maintaining market efficiency, as it helps align prices of the same or similar assets across different markets. When arbitrage opportunities exist, they are usually short-lived due to the actions of traders who seek to exploit them, helping to stabilize and equalize prices over time. In contrast, the other choices relate to different financial concepts that do not encapsulate the essence of arbitrage.