Arbitrage Strategies

Question 1

Explain the point of arbitrage strategies

Answer 1

Find inefficiencies and trade assets against each other in expectation that prices will converge.

Question 2

Name the three main types of arbitrage:

Answer 2

Pure
Risk
Statistical

Question 3

What is Pure Arbitrage?

Answer 3

Trading two or more assets that represent the same underlying.

Question 4

Where do most Pure Arbitrage opportunities surge?

Answer 4

New, less arbitraged markets.

Question 5

Is arbitrage risk-free?

Answer 5

Not really, usually best to invest in arbitrage strategy when you know the cause of the inefficiency.

Question 6

What is Risk Arbitrage?

Answer 6

Trading two companies involved in some corporate event (M&A or Bankruptcy)

Question 7

Is Risk Arbitrage correlated with the market?

Answer 7

No

Question 8

Is there skewness in Risk Arbitrage?

Answer 8

Usually yes, the worst loss is usually larger than the best gain. So it is negatively skewed.

Question 9

What is Statistical Arbitrage?

Answer 9

Trading two or more assets that are historically correlated, in the expectation that prices will continue to mean revert / converge.

Question 10

Main example of Statistical arbitrage? Explain it:

Answer 10

Pair Trading. Betting that equity spreads tend to revert to a mean in highly correlated assets.

Question 11

Can you use Index Reversals? (think Pair Trading)

Answer 11

You can, but need to be careful with different time differences and geographies.

Question 12

Other considerations on Pair Trading

Answer 12

Pairs are hit and miss, some work well, others don’t.
Consider using regressions instead of simple 1,0,-1 positions.