Working Paper: NBER ID: w26773
Authors: Todd M. Hazelkorn; Tobias J. Moskowitz; Kaushik Vasudevan
Abstract: We argue that deviations from the law of one price between futures and spot prices, known as bases, capture important information about liquidity demand for equity market exposure in global equity index futures markets. We show that bases (1) co-move with dealer and investor futures positions, (2) are contemporaneously positively correlated with spot and futures markets with the same sign, and (3) negatively predict futures and spot market returns with the same sign. These findings are uniquely consistent with our liquidity demand model and distinct from other explanations for bases, such as arbitrage opportunities or intermediary balance sheet costs. We show persistent supply-demand imbalances for equity index exposure reflected in bases, where compensation for meeting liquidity demand for that exposure is large (5-6% annual premium).
Keywords: liquidity demand; law of one price; equity index futures; basis
JEL Codes: F3; F31; F65; G1; G13; G15; G2; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| basis (Y20) | futures positions held by dealers (G13) |
| basis (Y20) | futures positions held by customers (G13) |
| basis (Y20) | futures market returns (G13) |
| basis (Y20) | spot market returns (G19) |
| basis (Y20) | future returns (G17) |
| basis (Y20) | liquidity demand for equity index exposure (G12) |