I thought I'd run a few arena balancing options by you. I'll try to keep my suggestions to the realm of "minor tweaks" instead of "complete overhaul". I'll also try to keep from repeating what others have already said (probably unsuccessfully, but I'm sure you'll let me know, lol)
1) The ability to use items in the arena. However, I'm thinking that these should be items that have some sort of tag that allows you to use them in the arena. For example, you wouldn't be able to use the regular healing potion, but you could use another item that has the same effect, but costs twice as much. This would make players think twice before using items, as they may lose more money than they will get.
Another option is to an equipped item that allows you to bring in X number of items. For example, a healer's pouch (misc equip slot) would allow you to bring 2 healing potions into the arena on that character.
2) Training with Xeona should be more rewarding. Currently, training with her has us save scumming for the CON boost, but I think that this can be fixed with a minor change. Instead of getting a bonus to your current ATK and DEF, you should get a bonus to the normal max for those stats. That way, players will be very hesitant to save scum, since both rewards are worth keeping.
Think of it this way, you train to increase your potential, but you only realize that potential through combat.
3) Different levels of magic should have different damage. From what I see, casting Fire 1 does the same damage as Fire 2 and Fire 3. Maybe have the damage of Fire 2 be the equivalent of your MAG stat +5 and Fire 3 would be +10?
4) The usefulness of magic is currently limited. I think there are a few spells that hit multiple enemies, but magic damage isn't that much overall. Maybe having the Intelligence stat be your "Magic Defense" stat would work? This way, you'd have something you can do against some of the high defense enemies.
For example, the earth elementals have a high defense, but they aren't all that smart. Thus, they don't really know that they should dodge that fireball.
5) Currently, small weapons only seem useful as a stat boost. Maybe give them a chance to apply some sort of status effect? For instance, daggers would have an increased chance to crit, caltrops would have a chance to lower an enemies agility, whips would have a chance to cause an enemy to "flinch" (resetting their current ATB), etc.
However, if you go this route, I'd suggest handicapping their damage. That way, you don't make the main weapon the "stat boost" weapon.
Well, that's all that I can think of, for now.