arbitragefri

Arbitagefri describes a market or financial model in which there are no opportunities to earn a risk-free profit with zero net investment. An arbitrage opportunity would require a portfolio that costs nothing or negative to set up today but yields a nonnegative payoff in all future states and a strictly positive payoff in at least one state. In practice, this implies that prices are mutually consistent enough to prevent free profits through immediate trading.

From a theoretical perspective, the no-arbitrage condition is central to modern financial economics. The fundamental theorem of asset pricing states that a market is arbitrage-free if and only if there exists an equivalent martingale measure under which the discounted prices of tradable assets evolve as martingales. Under such a measure, prices for derivatives are computed as the expected discounted payoff, simplifying valuation and ensuring consistency across assets.

In complete markets, no-arbitrage yields a unique fair price for every contingent claim. In incomplete markets, several equivalent martingale measures may exist, leading to a range of fair prices rather than a single number. Traders then focus on hedging possibilities and risk preferences to narrow prices. Real-world frictions—transaction costs, liquidity limits, and market impact—can create near-arbitrage opportunities that quickly vanish once costs are accounted for.

Practically, arbitrage-free modeling is a standard assumption in many pricing frameworks, including Black-Scholes and term-structure models. It provides a baseline for evaluating mispricings and testing trading strategies. While genuine arbitrage opportunities are rare and short-lived in efficient markets, the arbitrage-free principle remains essential for consistent pricing, risk management, and regulatory reporting.