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

96 Pages Posted: 24 Feb 2020

See all articles by Todd M. Hazelkorn

Todd M. Hazelkorn

AQR Capital Management, LLC

Tobias J. Moskowitz

Yale University, Yale SOM; AQR Capital; National Bureau of Economic Research (NBER)

Kaushik Vasudevan

Yale University

Multiple version iconThere are 2 versions of this paper

Date Written: February 2020

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).

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Suggested Citation

Hazelkorn, Todd and Moskowitz, Tobias J. and Vasudevan, Kaushik, Beyond Basis Basics: Liquidity Demand and Deviations from the Law of One Price (February 2020). NBER Working Paper No. w26773, Available at SSRN: https://ssrn.com/abstract=3543296

Todd Hazelkorn (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States
203 742 3914 (Phone)

HOME PAGE: http://www.aqr.com

Tobias J. Moskowitz

Yale University, Yale SOM ( email )

New Haven, CT 06520
United States

HOME PAGE: http://som.yale.edu/tobias-j-moskowitz

AQR Capital ( email )

Greenwich, CT
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Kaushik Vasudevan

Yale University ( email )

165 Whitney Avenue
New Haven, CT 06511
United States

HOME PAGE: http://www.kvasudevan.com

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