I need to know about index arbitrage and its origins in the financial marketplace.

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Request for Question Clarification by nenna-ga on 30 Apr 2004 13:24 PDT

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Nenna-GA
Google Answers Researcher

As related to trading, arbitrage is: "The simultaneous buying and
selling of a security at two different prices in two different
markets. The arbitrageur makes money by taking advantage of the price
disparity by selling in one market while simultaneously buying in the
other. Since the disparity is usually very small, a large volume is
required to lock in a significant profit for the arbitrageur.
Perfectly efficient markets present no arbitrage opportunities.
Fortunately, perfectly efficient markets seldom exist."

Ref: http://university.smartmoney.com/glossary/index.cfm?letter=A

Index arbitrage is exactly the same except rather than exploiting the
difference between *individual* securities one trades on the disparity
between an indexes spot price and an index future (derivative) price.

Here's a link explaining how one does this in practice (includes examples):
http://faculty.washington.edu/jduarte/finance_561/cn3p1.pdf

And here's a reference that includes a broader overview and history:
http://www.cme.com/files/indexarb.pdf