Mahdavi Damghani, Babak (2013). “The Non-Misleading Value of Inferred Correlation: An Introduction to the Cointelation Model”. Shleifer, Andrei (2000). Inefficient Markets: An Introduction to Behavioral Finance. Wilmott. 2013 (1): 50-61. doi:10.1002/wilm.10252. Kondor, Peter (2009). “Risk in Dynamic Arbitrage: Price Effects of Convergence Trading”. Xiong, Wei (2001). “Convergence trading with wealth effects”. 62 (2): 247-292. doi:10.1016/s0304-405x(01)00078-2. Journal of Financial Economics. Shleifer, Andrei; Vishny, Robert (1997). “The Limits of Arbitrage”. Clarendon Lectures in Economics.

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Arbitrage moves different currencies toward purchasing power parity. Americans would have to sell the Canadian dollars they received in exchange. Assume that a car purchased in the United States is cheaper than the same car in Canada. At the same time, Americans would buy US cars, transport them across the border, then sell them in Canada. Canadians would have to buy American dollars to buy the cars. Canadians would buy their cars across the border to exploit the arbitrage condition.

In the simplest example, any good sold in one market should sell for the same price in another. This type of price arbitrage is the most common, but this simple example ignores the cost of transport, storage, risk, and other factors. Traders may, for example, find that the price of wheat is lower in agricultural regions than in cities, purchase the good, and transport it to another region to sell at a higher price.

Since the cash flows are dispersed throughout future periods, they must be discounted back to the present. Each cash flow can be considered a zero-coupon instrument that pays one payment upon maturity. The present-value approach assumes that the bond yield will stay the same until maturity. In the present-value approach, the cash flows are discounted with one discount rate to find the price of the bond. For this reason, the discount rate may differ for each cash flow. In arbitrage-free pricing, multiple discount rates are used. This is a simplified model because interest rates may fluctuate in the future, which in turn affects the yield on the bond. The discount rates used should be the rates of multiple zero-coupon bonds with maturity dates the same as each cash flow and similar risk as the instrument being valued.