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I'm quite sure there are some sophisticated hedge funds out there that play arbitrage in the OTC market. With arbitrage I don't mean the semi-arbitrages (like volarb), but true riskless profits due to temporary dislocations and uncertainties.

I'm just wondering whether these HFs will at a certain point suffer 'reputational risk' in the IDB market, resulting in them progressively getting worse and worse quotes from banks? How does this work actually? Or are we all big boys and as long as the arb is not due to blatant mis-pricing (in which case I understand the bank would like to get a hint from the HF that their price is odd) everybody is happy?

I suppose this is a bit of a game theory question.

I struggle to come up with an example of actual arbitrage in the market, barring blatant mispricing.  So I am not sure there is room for any unhappiness.

I struggle to come up with an example of actual arbitrage in the market, barring blatant mispricing.  So I am not sure there is room for any unhappiness.

Let's say I personally witnessed one such possibiity, and I suspect it is related to Basel III and/or tax as it was not even a complex derivative. What should one do then? Although I personally am not involved in the business of looking for true arbitrages, I'm sure some HFs do.

I struggle to come up with an example of actual arbitrage in the market, barring blatant mispricing.  So I am not sure there is room for any unhappiness.

Let's say I personally witnessed one such possibiity, and I suspect it is related to Basel III and/or tax as it was not even a complex derivative. What should one do then? Although I personally am not involved in the business of looking for true arbitrages, I'm sure some HFs do.

I would imagine it depends if there's repeat business behind it. If you "pick off" someone who hasn't realised there's an arb there, they will probably be pissed off and curse you (or more likely the broker who didn't warn them)  but as soon as they realise, the opportunity is gone. If it's more structural, (i.e. as you say, regulatory or credit driven), then might even thank you for it. I am saying this from a commodities perspective.

I struggle to come up with an example of actual arbitrage in the market, barring blatant mispricing.  So I am not sure there is room for any unhappiness.

Let's say I personally witnessed one such possibiity, and I suspect it is related to Basel III and/or tax as it was not even a complex derivative. What should one do then? Although I personally am not involved in the business of looking for true arbitrages, I'm sure some HFs do.

I would imagine it depends if there's repeat business behind it. If you "pick off" someone who hasn't realised there's an arb there, they will probably be pissed off and curse you (or more likely the broker who didn't warn them)  but as soon as they realise, the opportunity is gone. If it's more structural, (i.e. as you say, regulatory or credit driven), then might even thank you for it. I am saying this from a commodities perspective.

Yes, as you point out, if arbitrage due to regulatory/credit/tax, then I think it's pretty much fair play. Besides, the particular arb I saw was really not wide enough for a Bugatti Veyron, but a Patek Philippe would have fit nicely  

I struggle to come up with an example of actual arbitrage in the market, barring blatant mispricing.  So I am not sure there is room for any unhappiness.

Let's say I personally witnessed one such possibiity, and I suspect it is related to Basel III and/or tax as it was not even a complex derivative. What should one do then? Although I personally am not involved in the business of looking for true arbitrages, I'm sure some HFs do.

If there is a genuine mispricing in the mkt (I hate the term "arbitrage"), I can't think of a dealer who would have a problem with it.  A dealer's main concern has to do with being adversely selected wrt to their peers.  As long as their price/appetite is in line with the mkt, they wouldn't have any issue whatsoever.

I struggle to come up with an example of actual arbitrage in the market, barring blatant mispricing.  So I am not sure there is room for any unhappiness.

Let's say I personally witnessed one such possibiity, and I suspect it is related to Basel III and/or tax as it was not even a complex derivative. What should one do then? Although I personally am not involved in the business of looking for true arbitrages, I'm sure some HFs do.

If there is a genuine mispricing in the mkt (I hate the term "arbitrage"), I can't think of a dealer who would have a problem with it.  A dealer's main concern has to do with being adversely selected wrt to their peers.  As long as their price/appetite is in line with the mkt, they wouldn't have any issue whatsoever.

Indeed, let's drop the term arbiitrage. But I don't know if it can even be called mispricing. For instance, hypothetical example, cost of capital Bank X = x%, Bank Y = y%, one is axed long, the other axed short, two different tax regimes, etc. This can lead to offer A < bid B. Is it a mispricing? I don't think so if they are both just pricing in their balance sheet costs, commissions, tax rate, transaction costs etc.

So instead of calling it arbitrage or mispricing, isn't it just market-making / making the market more efficient?

Let's say I personally witnessed one such possibiity, and I suspect it is related to Basel III and/or tax as it was not even a complex derivative. What should one do then? Although I personally am not involved in the business of looking for true arbitrages, I'm sure some HFs do.

If there is a genuine mispricing in the mkt (I hate the term "arbitrage"), I can't think of a dealer who would have a problem with it.  A dealer's main concern has to do with being adversely selected wrt to their peers.  As long as their price/appetite is in line with the mkt, they wouldn't have any issue whatsoever.

Indeed, let's drop the term arbiitrage. But I don't know if it can even be called mispricing. For instance, hypothetical example, cost of capital Bank X = x%, Bank Y = y%, one is axed long, the other axed short, two different tax regimes, etc. This can lead to offer A < bid B. Is it a mispricing? I don't think so if they are both just pricing in their balance sheet costs, commissions, tax rate, transaction costs etc.

So instead of calling it arbitrage or mispricing, isn't it just market-making / making the market more efficient?

Yes, the word arbitrage has become over-used as some magical buzzword synonym for making money. Yet it used to have a specific technical definition which may apply to your bank X and bank Y example. Just because bank X is willing to accept as low as A for some asset and bank Y is willing to pay as much as B for that same asset for reasons driven by their respective contexts does not mean they haven't "mispriced" their orders if better prices are readily available. Surely, bank X would prefer to get more and bank Y would prefer to pay less and would admit their orders were mispriced if they knew about each other's price tolerances.

Assuming bank X and bank Y are simultaneously in the market, they only need a matching engine to pair their already marketable orders rather than a market maker who provides liquidity in the case where bank X and Y arrive at the market at different times with different prices.

Assuming bank X and bank Y are simultaneously in the market, they only need a matching engine to pair their already marketable orders rather than a market maker who provides liquidity in the case where bank X and Y arrive at the market at different times with different prices.

True, my example is actually more a matching engine than market making as when I observed it, X & Y did simultaneously come with prices.

I think given what you, Martinghoul, and TW wrote, in this particular situation no party will feel unhappy about the matching engine making a riskless profit (there's a bit of counterparty risk).

Thanks.

Indeed...  And most of these "mispricings" (at least the ones I have observed recently) have to do with various regulatory changes.  I don't think any bank would have an issue with a client taking advantage of those.  In fact, they would welcome it, as it makes the mkt a little less fragmented and dysfunctional.