Rational Pricing

AAA

DEFINITION of 'Rational Pricing'

A financial theory that contends that the market prices of assets will represent the arbitrage-free pricing level for those assets. This is based on the assumption that any deviation from arbitrage-free price levels for an asset will result in arbitrageurs immediately trading away the profit opportunity on the asset until it trades at an arbitrage-free price.

INVESTOPEDIA EXPLAINS 'Rational Pricing'

A typical example of where the theory of rational pricing would be expected to come into play would be two identical assets trading in different markets. If the asset traded at a lower price in one market, an arbitrage trader would attempt to make a risk-free profit by purchasing the asset in the cheaper market by short selling the asset in the more expensive market. With enough volume, this arbitrage trading would cause the prices in both markets to converge to an equal value, removing the arbitrage opportunity.

RELATED TERMS
  1. Geographical Pricing

    Adjusting an item's sale price based on the buyer's location. ...
  2. Statistical Arbitrage

    A profit situation arising from pricing inefficiencies between ...
  3. Arbitrage

    The simultaneous purchase and sale of an asset in order to profit ...
  4. Market Arbitrage

    Purchasing and selling the same security at the same time in ...
  5. Arbitrage Pricing Theory - APT

    An asset pricing model based on the idea that an asset's returns ...
  6. Fixed-Income Arbitrage

    An investment strategy that attempts to profit from arbitrage ...
RELATED FAQS
  1. What is the difference between the cost of capital and the discount rate?

    The cost of capital refers to the actual cost of financing business activity through either debt or equity capital. The discount ... Read Full Answer >>
  2. How can an investor profit from a decline in the real estate sector?

    Speculation enables investors to profit from a decline in the real estate sector. The most popular forms of speculation for ... Read Full Answer >>
  3. How does arbitrage affect the price of exchange traded funds (ETFs)?

    Arbitrage may be used to bring the market value of an exchange-traded fund (ETF) back into line with the net asset value ... Read Full Answer >>
  4. How does the market share of a few companies affect the Herfindahl-Hirschman Index ...

    In economics and commercial law, the Herfindahl-Hirschman Index (HHI) is a widely used measure that indicates the amount ... Read Full Answer >>
  5. What does the rule of 70 indicate about a country's future economic growth?

    The rule of 70 could be used to indicate the approximate number of years that it would take a company's economic growth to ... Read Full Answer >>
  6. How is the rule of 70 related to the growth rate of a variable?

    The rule of 70 is related to the growth rate of a variable because it uses the growth rate in its approximation of the number ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Arbitrage Squeezes Profit From Market Inefficiency

    This influential strategy capitalizes on the relationship between price and liquidity.
  2. Active Trading Fundamentals

    An Introduction To Day Trading

    This article will take an objective look at day trading, who does it and how it is done.
  3. Options & Futures

    Trading The Odds With Arbitrage

    Profiting from arbitrage is not only for market makers - retail traders can find opportunity in risk arbitrage.
  4. Options & Futures

    Put-Call Parity And Arbitrage Opportunity

    Look at trades that are profitable when the value of corresponding puts and calls diverge.
  5. Options & Futures

    Hedge Funds Hunt For Upside, Regardless Of The Market

    Hedge funds seek positive absolute returns, and engage in aggressive strategies to make this happen.
  6. Fundamental Analysis

    Calculating Future Value

    Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
  7. Economics

    What is Deadweight Loss?

    Mainly used in economics, deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.
  8. Economics

    How to Do a Cost-Benefit Analysis

    The benefits of a given situation or business-related action are summed and then the costs associated with taking that action are subtracted.
  9. Fundamental Analysis

    Calculating the Herfindahl-Hirschman Index (HHI)

    The Herfindhal-Hirschman Index, (HHI) is a measure of market concentration and competition among market participants.
  10. Investing

    How To Implement A Smart Beta Investing Strategy

    Smart beta investing is the notion of re-writing investment rules to improve investment outcomes by targeting exposures to intuitive ideas or factors.

You May Also Like

Hot Definitions
  1. Mixed Economic System

    An economic system that features characteristics of both capitalism and socialism.
  2. Net Worth

    The amount by which assets exceed liabilities. Net worth is a concept applicable to individuals and businesses as a key measure ...
  3. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  4. Covered Call

    An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset ...
  5. Butterfly Spread

    A neutral option strategy combining bull and bear spreads. Butterfly spreads use four option contracts with the same expiration ...
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center