Beyond Basis Basics: Liquidity Demand and Deviations from the Law of One Price

Todd M. Hazelkorn, Tobias J. Moskowitz and Kaushik Vasudevan

No 26773, NBER Working Papers from National Bureau of Economic Research, Inc

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).

JEL-codes: F3 F31 F65 G1 G13 G15 G2 G23 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-ifn and nep-opm
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Published as TODD M. HAZELKORN & TOBIAS J. MOSKOWITZ & KAUSHIK VASUDEVAN, 2023. "Beyond Basis Basics: Liquidity Demand and Deviations from the Law of One Price," The Journal of Finance, vol 78(1), pages 301-345.

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