The Law Of One Price

Definition: In an efficient market all identical goods must have only one price.

Necessary Conditions 1. Same Good (same time) 2. Liquid Market 3. Perfect Information 4. No Transaction Costs

Why does the law of one price hold? Suppose it didn’t. The price of Gold is cheap in the New York and expensive in London. Then someone could: 1. Buy gold in New York 2. Immediately sell it in London 3. You’ll keep doing this until all your buying in New York drives the price up, all your selling in London drives the price down, and eventually the two prices are equal.

We call this arbitrage.