Different Strategies of Arbitrage

The way to get about the differences in the absolute economies through standardization, with a continuous process of buying and selling of securities, assets and to gain from the price differences with an element of risk attached is the Arbitrage clause attached in any financial profit and loss strategy.

Statistical Arbitrage

A set of quantitatively driven strategies which exploit the relative price dynamics of many such financial instruments mainly analyzing their pricing patterns and differential pricing to generate profits is how trading firms take advantage. Thought they are prominent in the markets however they are not in the high-frequency trading radar for investors and institutions.

Different Concepts

Mathematical models and pricing patterns of thousands of investment strategies are used to study and derive the best strategy to suit investors and trading fraternity. Different short-term and different holding patterns not only form the pricing data but from the corporate activity, lead and lag effects are used to determine the Statistical Arbitrage model to suit industry specific operation. The various concepts used are:

  • Time Series Analysis
  • Auto Regression and co-relation
  • Volatility Modeling
  • Principal Component Analysis
  • Efficient Frontier Analysis
  • Pattern finding Analysis

Types

  • Market Neutral Arbitrage involves taking a long position undervalued assets and a short position on assets which are overvalued simultaneously, which causes the long position to appreciate the value and depreciate in value for short position.
  • Cost Market Arbitrage seeks to exploit the price difference of similar assets across different markets, the assets are purchased during low valued market and sold during high valued markets
  • Cross Assets Arbitrage is based on the price discrepancies in the stock index futures and depends on the future value of underlying assets.
  • ETF Arbitrage which forms cross-asset arbitrage identifying the differences in the pricing between the ETF and the underlying assets

In the event stock to stock deal, the arbitrageur usually buys the share of the target company and then sells shares of the acquiring company with a ratio of the transaction similar to that of the proposed trading transactions. With cash to the stock deal, the money is borrowed to finance the stock buying and the shares are acquired from the newly acquired M & A which is bought at a lesser rate of the acquisition company. With many strategies which are at times workable for a particular situation may not be the time-tested the pairing options could be used to with the time series concepts analyzed.