Mechanism

The price discovery mechanism is the process of determining the price of an asset in the market through the interaction between buyers and sellers. In this process, buyers and sellers reach an equilibrium price at a given moment. Among the factors that influence this process are (1):

• Number of buyers
• Number of sellers
• Amount of supply available for sale in the market
• Recently traded quantities
• Availability of resources for buyers
• Future expectations regarding the traded asset
• News and events that influence the perception of the asset’s value

Price discovery is a sum of market sentiment at a given moment.

In a dynamic market, price discovery occurs continuously as assets are bought and sold. The price will sometimes fall below the average and sometimes rise above the average due to noise from uncertainties and transient changes in supply caused by buying and selling activities.

Price Differences and Market Arbitrage

It often happens that the same assets or goods are traded at different prices in different markets. This is due to variations in the factors that affect the price discovery mechanism (1) in each local market.

In some markets, where there is an excess supply of an asset, this may cause it to be traded at lower prices, while in other markets where there is a shortage of that asset, it may be traded at higher prices.

Market Arbitrage

These differences in market prices give rise to market arbitrage (Wikipedia). Market arbitrage involves buying a good or asset in a market where it is undervalued and selling it in a market where it is valued higher, thereby making an immediate profit from the price difference.

Market arbitrage is an activity that benefits markets, as it helps move assets from where there is a greater available supply to where there is greater unmet demand.