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On the relation between liquidity and the futures-cash basis: Evidence from a natural experiment

Jianlei Han and Zheyao Pan

Journal of Financial Markets, 2017, vol. 36, issue C, 115-131

Abstract: As a response to the 2015 Chinese stock market crash, regulators prohibited arbitrage activities in the index futures and cash markets. We use this natural experiment to test the hypothesis that liquidity and pricing efficiency causally affect each other. We find that resulting shift in the arbitrage boundary led to the breakdown of the two-way causality relation between liquidity and the absolute futures-cash basis. We thus confirm that the relation between liquidity and the absolute futures-cash basis is not driven by the omitted variable bias, but is indeed due to arbitrage.

Keywords: Futures-cash basis; Liquidity; Trading restrictions; Arbitrage (search for similar items in EconPapers)
JEL-codes: G01 G14 G18 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:finmar:v:36:y:2017:i:c:p:115-131