Arbitrage Theory

Arbitrage theory is the body of financial knowledge that explains why prices across different markets should be linked and why persistent price gaps are generally unsustainable. It is based on the law of one price, which states that identical assets should sell for the same price in an efficient market.

When this law is violated, arbitrageurs step in to buy the cheaper asset and sell the more expensive one, forcing the prices back into alignment. This theory underpins the entire structure of derivative pricing, as derivatives are essentially priced based on the cost of replicating the underlying asset.

In crypto, this theory explains the relationships between spot, futures, and options. It provides the logical framework for market efficiency.

Without the principles of arbitrage theory, financial markets would be chaotic and disconnected. It serves as the guiding logic for all market-making and algorithmic trading strategies.