What is the difference between pure, speculative and near arbitrage?

what is the difference between pure, speculative and near arbitrage?

Firstly, there is only arbitrage. Its like pregnancy; theres no matter of degree. Something is a pure arbitrage or its not arbitrage at all.

The other terms you note (speculative, near) are marketing terms designed to make something sound more riskless than it is.

To illustrate, example-arium for standard delivery (Ticker: EG) trades at 1000 in New York and 998 in Hong Kong. This may be arbitraged bysimultaneously:

BORROWING 998 and BUYING EG in Hong Kong (Cashflow: -998, Inventory: +1)

In this case, you made a riskless 2 dollars. You put no money down, you took no market risk and you captured free money (NB: In reality, you also have borrowing, transaction costs etc. to deal with).

Not only that, if you found 1 million units of EG, you would have made 2,000,000. Nice work if you can get it.

Hence arbitrage can be thought of as a true free lunch!

Sadly, arbitrage rarely exists in modern markets. The ones that are there are incredibly difficult to discover and, even if they do happen, usually disappear in (literal) microseconds (who doesnt like free money?).

The other strategies you mention may be *grounded* in arbitrage-like ideas, but do not satisfy all the conditions and, thus, are not arbitrage at all.

For example, company A is acquiring company B for $10 / share in cash. Today, before the announcement of the deal, the price of Company B is $7.50. The moment the deal is announced, Company B should be worth $10 a share. But it only rises to $9.20. Why the 80 cents left on the table? The risk the deal doesnt close.

This is Merger or Risk Arbitrage (an oxymoron, but a form of the near arbitrage you mention). You get to write insurance on the deal closing!

In this case, you would buy company B for 9.20 and then hedge your deal and / or market risk by selling index futures and/or the stock of the acquiring company. If the deal passes all the regulatory hurdles then, congratulations, you make that 80 cents! If not, like today with Shire and AbbVie pharma calling off their merger (10-15-2014), you lose huge:

Yes, thats a loss of over 30% in a single day.

There is risk – and hence it is not arbitrage.

Worse still, you have speculative arbitrage – which is where some tenuously related securities may, if the stars align and the statistics hold, converge to some common price….maybe.

Needless to say, this is not arbitrage. You need all the ingredients noted above.

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