The two-factor model in finance refers to an asset pricing model that considers the influence of both systematic and specific risk factors on the expected returns of an investment. It posits that an asset’s returns can be attributed to a combination of market-wide factors and factors specific to the asset. Arbitrage, in the financial context, involves exploiting price discrepancies between assets or markets to achieve risk-free profits, based on the assumption that prices will eventually adjust to eliminate any discrepancies.
