{"id":31071,"date":"2015-05-18T08:33:25","date_gmt":"2015-05-18T08:33:25","guid":{"rendered":"http:\/\/vskills.in\/certification\/blog\/?p=31071"},"modified":"2024-04-03T13:17:01","modified_gmt":"2024-04-03T07:47:01","slug":"no-arbitrage-profit-condition","status":"publish","type":"post","link":"https:\/\/www.vskills.in\/certification\/blog\/no-arbitrage-profit-condition\/","title":{"rendered":"NO ARBITRAGE PROFIT CONDITION"},"content":{"rendered":"<p style=\"text-align: center\"><a ref=\"magnificPopup\" href=\"http:\/\/vskills.in\/certification\/blog\/wp-content\/uploads\/2015\/05\/NO-ARBITRAGE-PROFIT-CONDITION.jpg\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-31098\" src=\"http:\/\/vskills.in\/certification\/blog\/wp-content\/uploads\/2015\/05\/NO-ARBITRAGE-PROFIT-CONDITION.jpg\" alt=\"NO ARBITRAGE PROFIT CONDITION\" width=\"174\" height=\"160\" \/><\/a><\/p>\n<p>Capital market equilibrium requires that market prices be set so that supply equals<br \/>\ndemand for each individual security. In the context of the state-preference framework, one condition necessary for market equilibrium requires that any two securities<br \/>\nor portfolios with the same state-contingent payoff vectors must be priced identically.&#8217;<br \/>\nOtherwise, everyone would want to buy the security or portfolio with the lower price<br \/>\nand to sell the security or portfolio with the higher price. If both securities or portfolios are in positive supply, such prices cannot represent an equilibrium. This condition is often called the single-price law of markets.<br \/>\nIf short selling is allowed in the capital market, we can obtain a second related<br \/>\nnecessary condition for market equilibrium, i.e., the absence of any riskless arbitrage<br \/>\nprofit opportunity. To short sell a security, an individual borrows the security from<br \/>\na current owner and then immediately sells the security in the capital market at the<br \/>\ncurrent price. Then, at a later date, the individual goes back to the capital market and repurchases the security at the then-current market price and immediately returns<br \/>\nthe security to the lender. If the security price fell over the period of the short sale,<br \/>\nthe individual makes a profit; if the security price rose, he or she takes a loss. In<br \/>\neither case the short seller&#8217;s gain or loss is always the negative of the owner&#8217;s gain<br \/>\nor loss over this same period.<br \/>\nWhen two portfolios, A and B, sell at different prices, where PA &gt; pB, but have<br \/>\nidentical state-contingent payoff vectors, we could short sell the more expensive portfolio and realize a cash flow of p,, then buy the less expensive portfolio, for a negative<br \/>\ncash flow of pB. We would realize a positive net cash flow of (p,\u2014 pB), and at the<br \/>\nend of the period, we could at no risk take our payoff from owning portfolio B to<br \/>\nexactly repay our short position in portfolio A. Thus the positive net cash flow at<br \/>\nthe beginning of the period represents a riskless arbitrage profit opportunity and Since<br \/>\nall investors are assumed to prefer more wealth to less, this arbitrage opportunity is<br \/>\ninconsistent with market equilibrium.<br \/>\nIn a perfect and complete capital market, any market security&#8217;s payoff vector<br \/>\ncan be exactly replicated by a portfolio of pure securities. Thus it follows that when<br \/>\nshort selling is allowed, the no\u2014arbitrage profit condition requires that the price of<br \/>\nthe market security be equal to the price of any linear combination of pure securities<br \/>\nthat replicates the market security&#8217;s payoff vector.<\/p>\n<p><a href=\"http:\/\/www.vskills.in\/certification\/accounting-banking-and-finance\">Click here for government certification in Accounting, Banking &amp; Finance<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Capital market equilibrium requires that market prices be set so that supply equals demand for each individual security. In the context of the state-preference framework, one condition necessary for market equilibrium requires that any two securities or portfolios with the same state-contingent payoff vectors must be priced identically.&#8217; Otherwise, everyone would want to buy the&#8230;<\/p>\n","protected":false},"author":625,"featured_media":31098,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_joinchat":[],"footnotes":""},"categories":[1519],"tags":[2345,2446,909],"class_list":["post-31071","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-accounting-banking-and-finance","tag-arbitrage","tag-profit","tag-risk"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v22.3 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>NO ARBITRAGE PROFIT CONDITION - Vskills Blog<\/title>\n<meta name=\"description\" content=\"The NO Arbitrage profit scenario. 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