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Arbitrage: The Key to Pricing Options

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Arbitrage has become associated in popular attitudes with the most ruthless and profit-driven of human impulses, but the opposite reputation might be more well-deserved. The ability to arbitrage is essential for the efficient operation of markets. An interesting application of the principle of arbitrage arose when it provided the breakthrough insight in economists’ solution to a formerly intractable problem: how to properly price the emergent financial instruments known as options.

Arbitrage has become associated in popular attitudes with the most ruthless and profit-driven of human impulses, but the opposite reputation might be more well-deserved. The ability to arbitrage is essential for the efficient operation of markets. An interesting application of the principle of arbitrage arose when it provided the breakthrough insight in economists’ solution to a formerly intractable problem: how to properly price the emergent financial instruments known as options.


Suggested citation: Nosal, Ed, and Tan Wang, 2004. "Arbitrage: The Key to Pricing Options," Federal Reserve Bank of Cleveland, Economic Commentary, 01.01.2004.

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