Timmy elsewhere

At El Reg.

About the difference between arbitrage and speculation.

It reads a bit oddly as now that charges have been laid in a case that I cannot mention I have to leave out any reference to that case I cannot mention. So there has to be a little bit of reading between the lines to work out why the piece has been published at all.

Still the core of that case not mentioned is that it\’s the nightmare of finance: arbitrage is risk free, arbitrage requires large budgets to work. Arbitrage desks have vastly higher budgets than risk taking speculative desks. Because there\’s no risk, see?

And then the nightmare: someone supposedly doing arbitrage decides to go and do speculation with that budget designed for arbitrage not speculation.

4 thoughts on “Timmy elsewhere”

  1. Tim:

    Everything you’ve said is true and the general explanation is perfectly satisfactory for those with minimal acquaintance with the concepts and terms.

    But your use of the term “arbitrage,” you should understand, is one somewhat specialized to exactly those types of large-volume, small individual value trades you describe. My understanding is that the process was “invented” and pioneered by an American, Bernard Baruch, as a young trading employee (and has been, from then, dubbed “arbitrage”) back in the 1920’s.

    But the word, in a generic sense (existing even before the specialized practice) merely means a process of reducing the difference between two entities at some “distance” from each other (we speak of “arbitrating” dispute–a process in which it is expected that the “distance” between the disputants will be reduced, not so much by a determination of which is “in the right” on which point but by disallowance of claims on both sides–performed by an “arbitrator.”

    In the larger meaning of the word, speculators (and the market itself) operate to arbitage supply and demand. (And I might add here that you, yourself, make that point–many times–when pointing out that speculation itself has the usual effect of dampening price volatility: that is exactly the same as saying that speculation performs an arbitraging function.) It’s just the difference between the plain meaning of the word and the specialized meaning in financial markets.

  2. Tim:

    Another thing I might point out is that, although
    bookmakers may be said to “arbitrage” by keeping their books even and “laying off” excess on one side or another with larger operations, a casino (as far as I can see) involves no such operation. Their advantage (and the source of their profitability) derives almost exclusively from the “odds” built into each game. As a matter of fact, they do experience risk on every turn of the wheel or card or throw of the dice. But, because the player’s risk is higher than that of the house, the house is able to minimize its risk of loss almost to the vanishing point in two ways: first, by limiting the size of individual bets their customer may place and, second, by their professional attention to maximizing the number of trials in a given time. The odds favoring the house are the smaller part. Profitability is due to Bernoulli’s Law of Large Numbers (which helps determine both the necessary rapidity of play and the safety to be gained by limitation of bet size for each example of house/patron odds advantage).
    The house may “lose” but rarely for long enough to cause discomfort

  3. Why can’t you mention it? It’s not a UK case is it? Or can’t you mention that?

    Tim adds: Yes, UK case. Charges have been laid so it’s contempt of court to discuss the details right now. Could prejudice the trial.

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