Rational Pricing

Did you know that assets can rationally price themselves? Well...now you do.

Rational pricing is the idea in financial economics that prices always end up leveling out to the “true” price, free of arbitrage opportunities. Let’s take a look at one asset selling in two markets to see what we mean by this.

If the stock Flubber is selling for $50 per share on the New York Stock Exchange and for $48 on the Hong Kong Stock Exchange, that’s an arbitrage opportunity. Investors will see this difference, and buy up the $48 stocks from Hong Kong SE, selling them for $50 on the New York SE, for a profit of $2 per stock. After Flubber is all arbitraged-up, the price difference disappears.

This is rational pricing at work, with prices of the same good equalizing itself. If the U.S. found all of the same goods on AliExpress for cheaper than on Amazon, causing a flock of customers to AliExpress, the cost of goods on AliExpress would go up from the increase in demand, and the price of goods on Amazon would go down from the sudden drop in demand. Eventually, the prices of the same stuff on the two platforms would be equal.

Arbitrageurs are only being rational, you know?