Price convergence

Price convergence The arbitration has the effect of making the prices of assets in different markets converge. As a result of arbitration, exchange rates, the price of goods and the price of financial instruments tend to converge in all markets. The speed at which prices converge is a measure of market efficiency. Arbitrage tends to reduce price discrimination, motivating people to buy a product where the price is low and where resale is higher. The arbitration moves the currencies of the countries to the”purchasing power parity.” For example, assume that a car bought in the U.S. is cheaper than the same car in Canada (ignoring transportation costs, taxes and regulations across countries). Canadians seize the opportunity and cross the border to buy cars in the U.S. and bring them to Canada. Some of these buyers buy cars for resale in Canada.Thus, Canadians would have to buy U.S. dollars to buy the cars, and this, in a large scale, would cause the U.S. dollar to appreciate against the Canadian dollar. Reached a point where the U.S. dollar price is so high that it will not be attractive for Canadians buying cars in the U.S., reaching the point of purchasing power parity. Similarly, arbitrage affects the difference between interest rates that governments pay various debt bonds.

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