Arbitrage Quotes

Arbitrage is not investing.

Arbitrage for its own sake has no merit of value, and is often a perversion of value — therefore though it may last for a while, it can never be sustained.

Two-thirds of professionally managed funds are regularly outperformed by a broad capitalization-weighted index fund with equivalent risk, and those that do appear to produce excess returns in one period are not likely to do so in the next. The record of professionals does not suggest that sufficient predictability exists in the stock market to produce exploitable arbitrage opportunities.

The realms of dating, marriage, and sex are all marketplaces, and we are the products. Some may bristle at the idea of people as products on a marketplace, but this is an incredibly prevalent dynamic. Consider the labor marketplace, where people are also the product. Just as in the labor marketplace, one party makes an offer to another, and based on the terms of this offer, the other person can choose to accept it or walk. What makes the dating market so interesting is that the products we are marketing, selling, buying, and exchanging are essentially our identities and lives. As with all marketplaces, every item in stock has a value, and that value is determined by its desirability. However, the desirability of a product isn’t a fixed thing—the desirability of umbrellas increases in areas where it is currently raining while the desirability of a specific drug may increase to a specific individual if it can cure an illness their child has, even if its wider desirability on the market has not changed. In the world of dating, the two types of desirability we care about most are: - Aggregate Desirability: What the average demand within an open marketplace would be for a relationship with a particular person. - Individual Desirability: What the desirability of a relationship with an individual is from the perspective of a specific other individual. Imagine you are at a fish market and deciding whether or not to buy a specific fish: - Aggregate desirability = The fish’s market price that day - Individual desirability = What you are willing to pay for the fish Aggregate desirability is something our society enthusiastically emphasizes, with concepts like “leagues.” Whether these are revealed through crude statements like, “that guy's an 8,” or more politically correct comments such as, “I believe she may be out of your league,” there is a tacit acknowledgment by society that every individual has an aggregate value on the public dating market, and that value can be judged at a glance. When what we have to trade on the dating market is often ourselves, that means that on average, we are going to end up in relationships with people with an aggregate value roughly equal to our own (i.e., individuals “within our league”). Statistically speaking, leagues are a real phenomenon that affects dating patterns. Using data from dating websites, the University of Michigan found that when you sort online daters by desirability, they seem to know “their place.” People on online dating sites almost never send a message to someone less desirable than them, and on average they reach out to prospects only 25% more desirable than themselves. The great thing about these markets is how often the average desirability of a person to others is wildly different than their desirability to you. This gives you the opportunity to play arbitrage with traits that other people don’t like, but you either like or don’t mind. For example, while society may prefer women who are not overweight, a specific individual within the marketplace may prefer obese women, or even more interestingly may have no preference. If a guy doesn’t care whether his partner is slim or obese, then he should specifically target obese women, as obesity lowers desirability on the open marketplace, but not from his perspective, giving him access to women who are of higher value to him than those he could secure within an open market.

A framework for identifying high-ROI Attraction opportunities is called advertising arbitrage: seek advertising opportunities where advertising inventory supply outpaces advertiser demand.

When a customer clicks through the license conditions to play the game, they’re agreeing to add their phone as a node in a distributed server. More players equal more servers—not for themselves, I might add, we never run a server node for any given game on the same host as a client for that game, that would be asking for trouble—but at the back end, we’re in the processor arbitrage market. The game programmers’ biggest problems are maintaining causality and object coherency while minimizing network latency—sorry,

In short, this is corruption by proxy. It is essentially a form of “political arbitrage,” where friends and family members of powerful political figures have positioned themselves to serve as conduits or middle men between those seeking influence and those who possess political power.

The Interborough issues are an example of a rather special group of situations in which analysis may reach more definite conclusions respecting intrinsic value than in the ordinary case. These situations may involve a liquidation or give rise to technical operations known as “arbitrage” or “hedging.

The commodity traders are arbitragers par excellence, trying to exploit a series of differences in prices. Because they’re doing deals to buy and to sell all the time, they are often indifferent to whether commodity prices overall go up or down. What matters to them is the price disparity – between different locations, different qualities or forms of a product, and different delivery dates. By exploiting these price differences, they help to make markets more efficient, directing resources to their highest value uses in response to price signals. They are, in the words of one academic, the visible manifestation of Adam Smith’s invisible hand.

Apple raised $17 billion in a bond offering in 2013. Not to invest in new products or business lines, but to pay a dividend to stockholders. The company is awash with cash, but much of that money is overseas, and there would be a tax charge if it were repatriated to the USA. For many other companies, the tax-favoured status of debt relative to equity encourages financial engineering. Most large multinational companies have corporate and financial structures of mind-blowing complexity. The mechanics of these arrangements, which are mainly directed at tax avoidance or regulatory arbitrage, are understood by only a handful of specialists. Much of the securities issuance undertaken by Goldman Sachs was not ‘helping companies to grow’ but represented financial engineering of the kind undertaken at Apple. What

In this kind of situation one might well ask: why continue to make the 80 percent of products that only generate 20 percent of profits? Companies rarely ask these questions, perhaps because to answer them would mean very radical action: to stop doing four-fifths of what you are doing is not a trivial change. What J-B Say called the work of entrepreneurs, modern financiers call arbitrage. International financial markets are very quick to correct anomalies in valuation, for example between exchange rates. But business organizations

As they worked through the order types, they created a taxonomy of predatory behavior in the stock market. Broadly speaking, it appeared as if there were three activities that led to a vast amount of grotesquely unfair trading. The first they called “electronic front-running”—seeing an investor trying to do something in one place and racing him to the next. (What had happened to Brad, when he traded at RBC.) The second they called “rebate arbitrage”—using the new complexity to game the seizing of whatever kickbacks the exchange offered without actually providing the liquidity that the kickback was presumably meant to entice. The third, and probably by far the most widespread, they called “slow market arbitrage.” This occurred when a high-frequency trader was able to see the price of a stock change on one exchange, and pick off orders sitting on other exchanges, before the exchanges were able to react. Say, for instance, the market for P&G shares is 80–80.01, and buyers and sellers sit on both sides on all of the exchanges. A big seller comes in on the NYSE and knocks the price down to 79.98–79.99. High-frequency traders buy on NYSE at $79.99 and sell on all the other exchanges at $80, before the market officially changes. This happened all day, every day, and generated more billions of dollars a year than the other strategies combined.

Tim Tigner began his career in Soviet Counterintelligence with the US Army Special Forces, the Green Berets. That was back in the Cold War days when, “We learned Russian so you didn't have to,” something he did at the Presidio of Monterey alongside Recon Marines and Navy SEALs. With the fall of the Berlin Wall, Tim switched from espionage to arbitrage. Armed with a Wharton MBA rather than a Colt M16, he moved to Moscow in the midst of Perestroika. There, he led prominent multinational medical companies, worked with cosmonauts on the MIR Space Station (from Earth, alas), chaired the Association of International Pharmaceutical Manufacturers, and helped write Russia’s first law on healthcare. Moving to Brussels during the formation of the EU, Tim ran Europe, Middle East, and Africa for a Johnson & Johnson company and traveled like a character in a Robert Ludlum novel. He eventually landed in Silicon Valley, where he launched new medical technologies as a startup CEO. In his free time, Tim has climbed the peaks of Mount Olympus, hang glided from the cliffs of Rio de Janeiro, and ballooned over Belgium. He earned scuba certification in Turkey, learned to ski in Slovenia, and ran the Serengeti with a Maasai warrior. He acted on stage in Portugal, taught negotiations in Germany, and chaired a healthcare conference in Holland. Tim studied psychology in France, radiology in England, and philosophy in Greece. He has enjoyed ballet at the Bolshoi, the opera on Lake Como, and the symphony in Vienna. He’s been a marathoner, paratrooper, triathlete, and yogi.  Intent on combining his creativity with his experience, Tim began writing thrillers in 1996 from an apartment overlooking Moscow’s Gorky Park. Decades later, his passion for creative writing continues to grow every day. His home office now overlooks a vineyard in Northern California, where he lives with his wife Elena and their two daughters. Tim grew up in the Midwest, and graduated from Hanover College with a BA in Philosophy and Mathematics. After military service and work as a financial analyst and foreign-exchange trader, he earned an MBA in Finance and an MA in International Studies from the University of Pennsylvania’s Wharton and Lauder Schools.  Thank you for taking the time to read about the author. Tim is most grateful for his loyal fans, and loves to correspond with readers like you. You are welcome to reach him directly at tim@timtigner.com.

During his time working for the head of strategy at the bank in the early 1990s, Musk had been asked to take a look at the company’s third-world debt portfolio. This pool of money went by the depressing name of “less-developed country debt,” and Bank of Nova Scotia had billions of dollars of it. Countries throughout South America and elsewhere had defaulted in the years prior, forcing the bank to write down some of its debt value. Musk’s boss wanted him to dig into the bank’s holdings as a learning experiment and try to determine how much the debt was actually worth. While pursuing this project, Musk stumbled upon what seemed like an obvious business opportunity. The United States had tried to help reduce the debt burden of a number of developing countries through so-called Brady bonds, in which the U.S. government basically backstopped the debt of countries like Brazil and Argentina. Musk noticed an arbitrage play. “I calculated the backstop value, and it was something like fifty cents on the dollar, while the actual debt was trading at twenty-five cents,” Musk said. “This was like the biggest opportunity ever, and nobody seemed to realize it.” Musk tried to remain cool and calm as he rang Goldman Sachs, one of the main traders in this market, and probed around about what he had seen. He inquired as to how much Brazilian debt might be available at the 25-cents price. “The guy said, ‘How much do you want?’ and I came up with some ridiculous number like ten billion dollars,” Musk said. When the trader confirmed that was doable, Musk hung up the phone. “I was thinking that they had to be fucking crazy because you could double your money. Everything was backed by Uncle Sam. It was a no-brainer.” Musk had spent the summer earning about fourteen dollars an hour and getting chewed out for using the executive coffee machine, among other status infractions, and figured his moment to shine and make a big bonus had arrived. He sprinted up to his boss’s office and pitched the opportunity of a lifetime. “You can make billions of dollars for free,” he said. His boss told Musk to write up a report, which soon got passed up to the bank’s CEO, who promptly rejected the proposal, saying the bank had been burned on Brazilian and Argentinian debt before and didn’t want to mess with it again. “I tried to tell them that’s not the point,” Musk said. “The point is that it’s fucking backed by Uncle Sam. It doesn’t matter what the South Americans do. You cannot lose unless you think the U.S. Treasury is going to default. But they still didn’t do it, and I was stunned. Later in life, as I competed against the banks, I would think back to this moment, and it gave me confidence. All the bankers did was copy what everyone else did. If everyone else ran off a bloody cliff, they’d run right off a cliff with them. If there was a giant pile of gold sitting in the middle of the room and nobody was picking it up, they wouldn’t pick it up, either.” In

This glut of watchdogs with overlapping jurisdictions encouraged regulatory arbitrage.

If everyone were free to migrate from one country to another, wages in rich countries would fall and wages in poor countries would rise, and the world would be a much more equal place. Of course, opposition to lower wages in rich countries is precisely why people are not permitted to migrate at will, and it is why meals and haircuts are so cheap in poor countries. The price of land, like the price of labor, cannot be arbitraged between rich countries and poor countries. Cheap housing in India or Africa cannot be brought up to American prices by simply moving the land across the ocean. The presence of cheap land and cheap labor in poor countries explains why price levels in poor countries are so much lower than in rich countries. The market sets the exchange rate to equalize the prices of steel, gasoline, automobiles, and computers—everything that can be and is part of international trade—but the price level depends on goods and services that cannot be traded. Because those are cheaper in poor places, the poorer the country, the lower are the average prices.

The use of capital markets by large companies today is mainly driven by tax and regulatory arbitrage, and undertaken by corporate treasurers with other people’s money. Financing

The labor arbitrage view of global trade, a model that goes back to the dawn of the First Industrial Revolution, assumes that manufacturing will always flow to low-cost countries. But the new automation view suggests that the advantages of cheap labor are shrinking while other factors—closeness to the ultimate consumer, transportation costs (including possible carbon taxes), flexibility, quality, and reliability—are rising.

price differences for the same product in two different settings, it’s called arbitrage.

Goldman would provide M&A advice as well as involve its foreign exchange desk to handle the currency exchange for the purchase price. If Goldman missed the deal—meaning our bankers were not involved—then proprietary trading might possibly be involved in merger arbitrage (oftentimes, Goldman would make more money in proprietary merger arbitrage than if it had been hired to advise on the deal). Goldman ensured that we looked at each transaction and each flow and had some way to make money from it.

My great grandfather used to buy plots of land in Russia and sell them in America. He had gold and silver mines in Australia, Japan and Malaysia. He took advantage of geographic arbitrage to buy low and sell high. You can do this right now. The current hot spot is the Philippines. Labour is their number one export, and they have great English.

In spite of strong similarities in the characteristics of the constituents of the S&P SmallCap and the Russell 2000, performance differs greatly. For the ten years ending December 31, 2003, the S&P SmallCap outdistanced the Russell 2000 by a margin of 11.6 percent to 9.5 percent. The surprisingly large performance differential results in large part from the games played by arbitrageurs during the reconstitution process. The arbitrage profits directly diminish the performance of the Russell benchmark, offering a free ride to managers evaluated against the Russell 2000.

WeWork’s core business was simple. It leased space, cut it up, and rented out each slice with an upcharge for hip design, flexibility, and regular happy hours. Other companies had risen, and in many cases fallen, by offering more or less the same service, which amounted to a straightforward arbitrage: lease long, rent short, and collect the margin.

It refuses to pursue business (even though there are big volumes to be had) that doesn’t involve value-added for its clients in some meaningful way, rather than simply benefit from labor cost arbitrage.

One Stanford op-ed in particular was picked up by the national press and inspired a website, Stop the Brain Drain, which protested the flow of talent to Wall Street. The Stanford students wrote, The financial industry’s influence over higher education is deep and multifaceted, including student choice over majors and career tracks, career development resources, faculty and course offerings, and student culture and political activism. In 2010, even after the economic crisis, the financial services industry drew a full 20 percent of Harvard graduates and over 15 percent of Stanford and MIT graduates. This represented the highest portion of any industry except consulting, and about three times more than previous generations. As the financial industry’s profits have increasingly come from complex financial products, like the collateralized debt obligations (CDOs) that ignited the 2008 financial meltdown, its demand has steadily grown for graduates with technical degrees. In 2006, the securities and commodity exchange sector employed a larger portion of scientists and engineers than semiconductor manufacturing, pharmaceuticals and telecommunications. The result has been a major reallocation of top talent into financial sector jobs, many of which are “socially useless,” as the chairman of the United Kingdom’s Financial Services Authority put it. This over-allocation reduces the supply of productive entrepreneurs and researchers and damages entrepreneurial capitalism, according to a recent Kauffman Foundation report. Many of these finance jobs contribute to volatile and counter-productive financial speculation. Indeed, Wall Street’s activities are largely dominated by speculative security trading and arbitrage instead of investment in new businesses. In 2010, 63 percent of Goldman Sachs’ revenue came from trading, compared to only 13 percent from corporate finance. Why are graduates flocking to Wall Street? Beyond the simple allure of high salaries, investment banks and hedge funds have designed an aggressive, sophisticated, and well-funded recruitment system, which often takes advantage of [a] student’s job insecurity. Moreover, elite university culture somehow still upholds finance as a “prestigious” and “savvy” career track.6

Le catalogue des œuvres d’Avicenne comporte environ 500 titres, 456 rédigés en arabe et 23 en persan. Sur cet ensemble, 160 livres nous sont parvenus. Son Livre de l’arbitrage équitable en 20 volumes, détruit lors du sac d’Ispahan (1034), répondait à... 28 000 questions !

This was classic regulatory arbitrage. Bank managers were not unaware of the risks they courted. Wall Street has simply never kowtowed to regulations that pull the plug on profitable businesses. They always find their way around them.

Many arbitrage vendors get shut down right after Christmas because they sell thousands of products to customers who don’t receive them until February.

Researchers and research organizations who aim to 'change the way people think or do' must have the freedom, not only to be contrarian, bot also the be wrong. Contrariness sometimes leads to failure, but from failure comes learning, and from learning very often comes implausible utility, the useful and surprising. Contrariness is not the only thing required of researchers to achieve implausible utility, however. The second thing that is required is informedness. Conventional wisdom and existing paradigms 'work' - that is why we adopt them in the first place and that is why we resist so strongly their overthrow. If a researcher is going to take seriously observations and ideas that go against conventional wisdom, the researcher had better have good reasons for doing so - and the discipline to develop those good reasons. These reasons we call informedness - 'inside' knowledge or capabilities the researcher possess that the researcher's peers don't yet have. This inside knowledge makes the researcher think the researcher is right and conventional wisdom is wrong. The researcher is an 'informed contrarian,' going against conventional wisdom but in an informed way to reduce the tremendous risk associated with going against that very wisdom. Like a financial arbitrageur who uses greater informedness about the true value of an asset to buy those assets currently undervalued by conventional wisdom, informed contrarian researchers are research arbitrageurs who use their greater informedness about the value of a research observation or idea to take seriously those ideas currently undervalued by conventional wisdom.

The time was right for our project because the necessary high-quality databases and the powerful new computers with which to explore them were just becoming affordable. By luck, one of our researchers almost immediately found the basic idea behind statistical arbitrage.

Arbitrages: The purchase of a security and the simultaneous sale of one or more other securities into which it was to be exchanged under a plan of reorganization, merger, or the like. Liquidations: Purchase of shares which were to receive one or more cash payments in liquidation of the company’s assets. Operations of these two classes were selected on the twin basis of (a) a calculated annual return of 20% or more, and (b) our judgment that the chance of a successful outcome was at least four out of five. Related Hedges: The purchase of convertible bonds or convertible preferred shares, and the simultaneous sale of the common stock into which they were exchangeable. The position was established at close to a parity basis—i.e., at a small maximum loss if the senior issue had actually to be converted and the operation closed out in that way. But a profit would be made if the common stock fell considerably more than the senior issue, and the position closed out in the market. Net-Current-Asset (or “Bargain”) Issues: The idea here was to acquire as many issues as possible at a cost for each of less than their book value in terms of net-current-assets alone—i.e., giving no value to the plant account and other assets. Our purchases were made typically at two-thirds or less of such stripped-down asset value. In most years we carried a wide diversification here—at least 100 different issues.

What we have here is a clear, systematic source of investment mispricing, ripe for intertemporal arbitrage (a term synonymous with Austrian Investing itself).

When mortals go through a prosperous period, it seems to be human nature for expenses to balloon. We are going to be the exception. I have just informed the purchasing department that they should no longer purchase paper clips. All of us receive documents every day with paper clips on them. If we save these paper clips, not only will we have enough for our own use, but we will also, in a short time, be awash in the little critters. Periodically, we will collect excess paper clips and sell them (since the cost to us is zero, the Arbitrage Department tells me the return on capital will be above average). This action may seem a little petty, but anything we can do to make our people conscious of expenses is worthwhile.

Arbitrage,” in the usual sense, means to make money by taking advantage of differences in the price of something between different markets. It is spatial, in other words, and hinges on the arbitrageur knowing what is going on simultaneously in different places. Microsoft is making money by taking advantage of differences in the price of technology in different times. Temporal arbitrage, if I may coin a phrase, hinges on the arbitrageur knowing what technologies people will pay money for next year, and how soon afterwards those same technologies will become free.

Walking Blues Not Packaged for Individual Sale I learned the word bodega the same day I learned arbitrage riding with you down to Richmond to buy armloads of the cheap cigarettes, the ones you'd packed duffled aboard a Chinatown bus to resell on the sly in Brooklyn. Back on Earth, driving your truck home alone, I turned both words over in my mouth again and again, polishing the gemstones. My mother learned bodega from 'Diamonds on the Soles of Her Shoes' and asked me to take a picture of the first one I saw when I visited you When I tried, you told me Don't preserve the evidence, dumbshit so I never got one. Besides, whatever glitter Paul Simon burnished onto the word had gotten lost among the toilet paper rolls and rubber gloves that lined the ceilings, though I found a glimmer of it napping on the warmth of the ATM, a cat who was named Lucy not after diamonds but after the cigarettes. This was back before you figured out how much more you can make by just stealing what you wanted. Back when I still thought of myself as the kind of friend who would visit you in jail.

A moral inversion is a form of political arbitrage. Nietzsche criticized it when Christianity did it, but also had to admit it worked.78 Why did it work? One view is that “afflict the comfortable and comfort the afflicted” is essentially the same concept as buy low/sell high. You’re supporting something when it’s low and shorting it when it’s high. The mood of the words is very different, of course. The political arbitrage of supporting those with low status and attacking those with high status is typically framed as a moral imperative, while the financial arbitrage of buying assets with low value and selling assets of high value is usually portrayed as a dispassionate mechanism for gaining financial capital. But recall that people do sometimes make moral arguments for buying low and selling high (“it helps markets become more efficient”). So you might invert the mood of the words on the other side too, and think of “afflicting the comfortable and comforting the afflicted” as a dispassionate mechanism for gaining political capital.

Someone who can pick who to label as “comfortable”, who can pick the axis of political arbitrage, can keep knocking down the “comfortable” while themselves remaining very comfortable. And that means the concept of “afflicting the comfortable and comforting the afflicted” can also be a mechanism for maintaining political capital.

The Higginson & Co. deal was baffling. Even if Ivar could control the market, so that he could buy low there and sell high in London, it wasn’t clear why he would give such arbitrage profits to Higginson & Co., instead of keeping them for himself. Outside the rarefied world of investment banking, this complicated transaction might have been called a bribe. But Higginson & Co. accepted it and, as Ivar had hoped, began praising him to the firm’s counterparts in New York, including Donald Durant. At the same time, Ivar asked a Swedish stockbroker named Gustav Lagerkrantz to visit Durant and to recommend, casually and unobtrusively, that Durant ask to meet with Ivar. Durant had no reason to suspect a connection. From Durant’s perspective, Lagerkrantz was just another broker seeking access to one of America’s top banks.

Years later, people would ask me, “How did you know when and what to buy?” But all I basically did was create a massive arbitrage—a fixed-rate instrument in an inflationary environment. I essentially took on $4 billion of nonrecourse debt at an average interest rate of 6 percent in an environment with inflation of 9 percent or higher. That means I was already making 3 percent returns the second the deal closed—without doing a thing to the assets. Sure, we picked some terrific properties, but every one didn’t have to be Class A.

Modernity has replaced ethics with legalese, and the law can be gamed with a good lawyer. So I will expose the transfer of fragility, or rather the theft of antifragility, by people “arbitraging” the system. These people will be named by name. Poets and painters are free, liberi poetae et pictores, and there are severe moral imperatives that come with such freedom. First ethical rule: If you see fraud and do not say fraud, you are a fraud.

If you want to do arbitrage to get started, I recommend Chris Green’s book

ABOUT THE AUTHOR Tim Tigner began his career in Soviet Counterintelligence with the US Army Special Forces, the Green Berets. That was back in the Cold War days when, “We learned Russian so you didn't have to,” something he did at the Presidio of Monterey alongside Recon Marines and Navy SEALs. With the fall of the Berlin Wall, Tim switched from espionage to arbitrage. Armed with a Wharton MBA rather than a Colt M16, he moved to Moscow in the midst of Perestroika. There, he led prominent multinational medical companies, worked with cosmonauts on the MIR Space Station (from Earth, alas), chaired the Association of International Pharmaceutical Manufacturers, and helped write Russia’s first law on healthcare. Moving to Brussels during the formation of the EU, Tim ran Europe, Middle East and Africa for a Johnson & Johnson company and traveled like a character in a Robert Ludlum novel. He eventually landed in Silicon Valley, where he launched new medical technologies as a startup CEO. In his free time, Tim has climbed the peaks of Mount Olympus, hang glided from the cliffs of Rio de Janeiro, and ballooned over Belgium. He earned scuba certification in Turkey, learned to ski in Slovenia, and ran the Serengeti with a Maasai warrior. He acted on stage in Portugal, taught negotiations in Germany, and chaired a healthcare conference in Holland. Tim studied psychology in France, radiology in England, and philosophy in Greece. He has enjoyed ballet at the Bolshoi, the opera on Lake Como, and the symphony in Vienna. He’s been a marathoner, paratrooper, triathlete, and yogi.

The stocks that had gone up the most did worse as a group than the market in the next few weeks, and the stocks that were the most down did better. Historically, the annualized return was 20 percent from buying the one-tenth of stocks that had fallen most and selling short the tenth that had risen most. We called the system MUD, as it was constructed from the “most-up, most-down” stocks. As UCI mathematician William F. Donoghue would joke, “Thorp, my advice is to buy low and sell high.” The portfolio of long stocks tracked the market and the short portfolio did the opposite, so the two sides together mostly canceled the movement of the market. This gave us what we liked, a market-neutral portfolio. But that portfolio still had larger fluctuations in value than our usual investments, so we put statistical arbitrage aside for the time being.

To control risk further, I replaced Bamberger’s segregation into industry groups by a statistical procedure called factor analysis. Factors are common tendencies shared by several, many, or all companies. The most important is called the market factor, which measures the tendency of each stock price to move up and down with the market. The daily returns on any stock can be expressed as a part that follows the market plus what’s left over, the so-called residual. Financial theorists and practitioners have identified a large number of such factors that help explain changes in securities prices. Some, like participation in a specified industry group or sector (say, oil or finance) mainly affect subgroups of stocks. Other factors, such as the market itself, the levels of short-term and long-term interest rates, and inflation, affect nearly all stocks. The beauty of a statistical arbitrage product is that it can be designed to offset the effects of as many of these factors as you desire. The portfolio is already market-neutral by constraining the relation between the long and short portfolios so that the tendency of the long side to follow the market is offset by an equal but opposite effect on the short side. The portfolio becomes inflation-neutral, oil-price-neutral, and so on, by doing the same thing individually with each of those factors. Of course, there is a trade-off: The reduction in risk is accompanied by limiting the choice of possible portfolios.

To do index arbitrage, PNP developed techniques in the mid-1980s for finding baskets of stocks that did a particularly good job of tracking an index. We used this very profitably the day after “Black Monday,” October 19, 1987, to capture a spread of over 10 percent between the S&P 500 Index and the futures contracts on it. Quants have honed this to a fine art and, through their trading, generally keep the price discrepancy very small. To cut taxes, start with a tracking basket and, each time a stock drops, say, 10 percent, sell the loser and reinvest the proceeds in another stock or stocks chosen so the new basket continues to track well. If you want only short-term losses, which is usually best, sell within a year of purchase. I advise anyone considering doing this in a serious way to study it first with simulations using historical databases.

companies. When a company received an order for a product, that company would send the order to the fulfillment company who would then ship the company’s product to the customer. The fulfillment company would charge the company for this service, while leveraging their large shipping volume to get good shipping rates. The fulfillment company does what they are good at which is storing inventory, picking, packing, and shipping orders while each company that uses the fulfillment company continues to do what they are good at which is selling their products. The companies also benefit by not having to have their own warehouse and shipping department to process all of their own orders themselves. It was a win-win relationship. The difference between a traditional fulfillment center and Amazon’s FBA program is that Amazon is not just the fulfillment company, they are also the marketplace. They have an active interest in seeing the products sell. Amazon makes money by charging a commission on the products sold on Amazon.com as well as the fees that they charge to use FBA (fees explained a little later). So you are not just sending your products to a traditional fulfillment center and then left on your own to find customers and make sales. Amazon.com is the website that you are selling on and they are the ones doing the fulfillment for you. They WANT your items to sell just as much as you do; maybe even more so since they get paid whether you are making a profit or not. More on this later to make sure

Structurally, is it an industry where companies have advantages of size and economies of scale? Are there ways to grow the business organically or through M&A? What multiples will I likely have to pay for companies I acquire, and is that number a large enough discount from the multiple I’d expect my company to trade at? This is important because the arbitrage between our cost of capital and what multiple we’re able to buy companies at is the biggest value-creation lever in a roll-up. Improving the actual profitability of the business is the second-biggest lever.

The fed funds market is not dead, however, mainly because all of its market participants don’t have access to the IOER. Due to the legal structure of the Federal Home Loan Banks (FHLBs), they can’t loan cash to the Fed. That makes them the largest lender of fed funds out there, supplying about 75% of the cash in the market each day. To add insult to injury, foreign banks are often the cash borrowers, relending the funds back to the Fed and taking advantage of the spread between fed funds and IOER. Yes, effectively arbitraging the U.S. government.

Why is statistical arbitrage so-called? Arbitrage originally meant a pair of offsetting positions that lock in a sure profit. An example might be selling gold in London at $300 an ounce while at the same time buying it at $290 in New York for a $10 gain. If the total cost to finance the deal and to insure and deliver the New York gold to London were $5, it would leave a $5 sure profit. That’s an arbitrage in its original usage. Later the term was expanded to describe investments where risks are expected to be largely offsetting, with a profit that is likely, if not certain. For instance, in what is called merger arbitrage, company A trading at $100 a share may offer to buy company B, trading at $70 a share, by exchanging one share of company A for each share of company B. The market reacts instantly and company A’s shares drop to, say, $88 while company B’s shares jump to $83. Merger arbitrageurs now step in, buying a share of B at $83 and selling short a share of A at $88.

That was because of the uptick rule. The rule was part of the Securities Exchange Act of 1934 (rule 10a-1). It specified that, with certain exceptions, short-sale transactions are allowed only at a price higher than the last previous different price (an “uptick”). This rule was supposed to prevent short sellers from deliberately driving down the price of a stock. Seeing an enormous profit potential from capturing the unprecedented spread between the futures and the index, I wanted to sell stocks short and buy index futures to capture the excess spread. The index was selling at 15 percent, or 30 points, over the futures. The potential profit in an arbitrage was 15 percent in a few days. But with prices collapsing, upticks were scarce. What to do? I figured out a solution. I called our head trader, who as a minor general partner was highly compensated from his share of our fees, and gave him this order: Buy $5 million worth of index futures at whatever the current market price happened to be (about 190), and place orders to sell short at the market, with the index then trading at about 220, not $5 million worth of assorted stocks—which was the optimal amount to best hedge the futures—but $10 million. I chose twice as much stock as I wanted, guessing only about half would actually be shorted because of the scarcity of the required upticks, thus giving me the proper hedge. If substantially more or less stock was sold short, the hedge would not be as good but the 15 percent profit cushion gave us a wide band of protection against loss.

The best way to avoid these tactics from being used by you or against you is by befriending the other party before the negotiations start. Good relationships and rapport in a neutral environment may prove productive later at the negotiating table. Overall,

The sanctity of these accounts can lead to seemingly bizarre behavior, such as simultaneously borrowing and lending at very different rates. David Gross and Nick Souleles (2002) found that the typical household in their sample had more than $5,000 in liquid assets (typically in savings accounts earning less than 5 percent a year) and nearly $3,000 in credit card balances, carrying a typical interest rate of 18 percent or more. Using the money from the savings account to pay off the credit card debt amounts to what economists call an arbitrage opportunity—buying low and selling high—but the vast majority of households fail to take advantage.

Arbitrage is a "risk-free" profit, but for most of us, it might as well be a mirage. Markets are quick to eliminate such opportunities.

finance systems struggled to deal with the escalation in business volumes. Due to process improvements in the outsourced F&A processes, accounts payable and receivable and monthly closing have now become a military operation. He commented, ‘Labor arbitrage is temporary, but process improvement is permanent. Silent running was absolutely the main objective and it is not a problem for the organization any more. We achieved it more cheaply that we used to’.