Arbitrageur

An arbitrageur can simply be defined as a person who engages in arbitrage. However, this rather oversimplifies the term, which can cover a range of activities that include true (riskless) arbitrage, and activities that are similar but which carry some level of risk. The latter cover many of the activities of hedge funds and proprietary traders.

By exploiting arbitrage opportunities, arbitrageurs reduce them. This ensures that arbitrage opportunities remain small and transient, and that we can therefore rely on the no-arbitrage assumption when valuing securities.

The terms arbitrage and arbitrageur are also used to cover activities that, unlike true arbitrage, are risky: it is possible to make a loss, and often there is a significant risk of making large losses. These include statistical arbitrage and risk arbitrage.

Some of these more risky strategies have a high probability of making high returns, with a lower probability of very large losses. For a hedge fund manager who is paid a percentage of gains, but does not share in losses, this is very attractive. The same often applies to proprietary traders. As so often with fund management, there is an agency issue that is worsened by the incentives fund managers are given.

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