What is the 'No-Arbitrage' principle?
What is the 'No-Arbitrage' principle?
Approach: Explain the assumption that markets are efficient enough to eliminate risk-free profit.
The assumption that in a competitive market, prices are set such that no arbitrage opportunities exist. It is a fundamental building block for pricing derivatives.
Follow-up: Which famous formula relies on this principle? (Black-Scholes)
Key concepts: equilibrium, market efficiency.