NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Beyond Basis Basics: Liquidity Demand and Deviations from the Law of One Price

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

NBER Working Paper No. 26773
Issued in February 2020, Revised in August 2020
NBER Program(s):Asset Pricing, International Finance and Macroeconomics

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).

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Document Object Identifier (DOI): 10.3386/w26773

 
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