ARBITRAGE (from the French arbitrer, in the secondary sense of comparing and settling accounts, derived in its turn from the primary sense of arbitrating disputes), is a term that is applied both to a calculation and to a trade: 1st, To the calculation of the relative simultaneous values at any particular moment of any particular merchandise, on one market, in terms of the quotations on one or more other markets, taking, of course, the exchanges into account; and 2d, To the business founded on such calculations, of buying (or vice versa) wholesale in the cheapest market for the time being, and simultaneously reselling (or vice versa) equal amounts in the dearest market, or if not simultaneously, at least as nearly simultaneously as post and telegraph will permit. Arbitrage proper is a separate, distinct, and well-defined business, with three main branches. Two of these, viz., arbitrage or arbitration in bullion and coins, and arbitration in bills, also called the arbitration of exchanges, fall within the businesses of bullion dealing and banking respectively. The third, arbitrage in stocks and shares, is arbitrage properly so called, and so understood, whenever the word is mentioned without qualification among business men, and it is strictly a Stock Exchange business. A few of the great financial firms outside the Stock Exchange combine the three arbitrations; they are dealers in bullion, in bills, and in stocks and shares all over the world; but, as a rule, the arbitrage properly known as such, is the business of an arbitrageur, who is almost always a member of a Stock Exchange or “Bourse,” and his arbitrations with very few exceptions are neither in bullion nor in bills, but in Government and other stocks and shares. In this strict and accurate sense, arbitrage ...may be defined to be a traffic, consisting in the purchase (or sale) on one Stock Exchange, and simultaneous or nearly simultaneous, re-sale (or re-purchase) on another Stock Exchange, of the same amount in the same stocks or shares, which at any moment are found, on telegraphic or other advices, to be quoted and negotiable on two or more markets at a difference in price (arising from whatever temporary cause), sufficient to cover the cost of transmission, commission, interest, insurance, and leave an adequate profit over and above to be divided by the operators at both ends. The benefit to the various communities at large resulting from the operations of the arbitrageur consists—first, in the general and constant process of equalisation, equilibration, and the consequent stability in the prices of a large number of stocks and shares, and of an enormous amount of capital throughout the world; and second, in the greater inducement thus afforded for the economy of idle capital, by means of temporary investment in interest-bearing securities with a minimised risk of fluctuation. The great Government loans are, in the first instance, the natural subject-matter of arbitrage; and then, in a minor degree, a variety of other securities. British Consols, however, form one great exception to the rule, inasmuch as, from one cause or another (but mainly because they are almost entirely held in one country), no arbitrage business is done in these Consols, notwithstanding that they can be now dealt in “To Bearer.” On the other hand, there is an enormous arbitrage business in the new French Five per cents., which, with the United States “Five-Twenties,” covering between them a round five hundred millions sterling, probably stand first in the present list of arbitrage stocks. Indeed, but for the system of arbitrage, it is not easy to see how the great French loans of 1871-72 could have been carried at all without convulsing the financial world. Arbitrage, however, by making the new security universally negotiable, enabled all the great bankers and capitalists of the world—European, American, and East Indian—to join hands simultaneously in concluding an operation gigantic even for modern times. Next to “French Fives” and “U. S. Five-Twenties,” on the arbitrageur’s list would come, in various order, according to the men and the circumstances, “Turkish,” “Egyptian,” “Italian,” “Spanish” “Russian,” some South American stocks, and to a very considerable extent, the shares and obligations of the great Lombardo-Venetian Railways. And these stocks, if we add some East Indian securities, cover perhaps the widest area of international arbitrage. But a vast variety of minor securities constitute financial flora, so to speak, with minor and local areas of distribution, known only to particular localities, or to financial specialists. It has been stated above that some great financial houses do each kind of arbitration themselves. Similarly, one or two great firms of arbitrageurs do their own bill-broking; but although arbitrage business is carried on by a considerable number of the leading Stock Exchange firms, there are perhaps only two that arbitrate their own bills—this arising from certain regulations that were passed by the London Stock Exchange in 1829 not having a retrospective effect. With these exceptions, the arbitrageurs do not undertake the banking part of the business themselves, but pay their bankers a margin to do it for them. The details of the system of arbitrage, and all the combinations with other business that may arise, constitute a special profession.
The literature of the subject is extremely meagre. Mr Goschen’s Theory of Foreign Exchanges, London, 1866, is general and theoretical, but throws great light upon particular aspects of the philosophy of arbitrage, without touching specially on the details of the subject itself. The principal other works are—Kelly’s Cambist, 1811, 1835; Otto Swoboda, Die Kaufmännische Arbitrage, Berlin, 1873, and Börse und Actien, Cologne, 1869; Coquelin et Guillaumin, Dictionnaire de T Economie politique, Paris, 1851-53; Ottomar Haupt, London Arbitrageur, London, 1870; Charles le Touzé, Traité Théorique et Pratique du Change, Paris, 1868; Täte, Modem Cambist, London, 1868; Simon Spitzer, Ueber Münz-und Arbitragenrechnung, Vienna, 1872; J. W. Gilbart, Principles and Practice of Banking, London, 1871.
