Does Spurious Mean Reversion in Basis Changes Still Exist After the Introduction of Exchange Traded Funds

Review of Futures Markets Vol 17(4): Article 4, 2009

Posted: 1 Jun 2020

See all articles by Nivine Richie

Nivine Richie

University of North Carolina Wilmington

Jayaram Muthuswamy

Kent State University

Reuben Segara

University of Sydney Business School; Financial Research Network (FIRN)

Robert I. Webb

University of Virginia - McIntire School of Commerce

Date Written: December 6, 2008

Abstract

In their seminal Journal of Finance article, Miller, Muthuswamy, and Whaley (MMW) [1994] document that the observed mean reversion of changes in the basis of cash and stock index futures prices is likely illusory. MMW use a simple time-series model to suggest that the apparent mean-reversion in the basis is a spurious artifact of non-synchronous prices between index futures and cash markets – rather than an indication of exploitable weak-form market inefficiency. Because the MMW effect is predominantly driven by liquidity differentials between cash and futures prices, the question naturally arises as to whether one would observe the same MMW phenomenon in the behaviour of the “basis” or difference between more actively traded ETF and cash market prices. This study attempts to answer that question by examining the “basis” behavior of the Standard and Poor’s Depository Receipt (SPDR) ETF traded on the American Stock Exchange. Overall, we find that the MMW phenomenon still persists strongly after the advent of Exchange Traded Funds. Moreover, an examination of the spread or “basis” between cash and ETF prices and the spread or “basis” between futures and ETF prices shows that the apparent mean reversion in both is even more pronounced than in the basis between cash and futures prices. This demonstrates that the MMW effect is extremely robust and unlikely to “go-away” soon.

Keywords: Observed Basis Mean Reversion, Spurious Basis Predictability, Cash Index, Exchange Traded Funds, SPDR’s, Index Futures, Non-Synchronicity Between Cash and Derivative Securities

JEL Classification: G11, G12

Suggested Citation

Richie, Nivine and Muthuswamy, Jayaram and Segara, Reuben and Webb, Robert I., Does Spurious Mean Reversion in Basis Changes Still Exist After the Introduction of Exchange Traded Funds (December 6, 2008). Review of Futures Markets Vol 17(4): Article 4, 2009, Available at SSRN: https://ssrn.com/abstract=3592021

Nivine Richie

University of North Carolina Wilmington ( email )

Wilmington, NC 28403
United States

Jayaram Muthuswamy

Kent State University ( email )

Kent, OH 44242
United States

Reuben Segara (Contact Author)

University of Sydney Business School ( email )

Sydney
Australia
+61 2 9351 8790 (Phone)
+61 2 9351 6461 (Fax)

HOME PAGE: http://www.sydney.edu.au/business/about/our-people/academic-staff/reuben-segara.html

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Robert I. Webb

University of Virginia - McIntire School of Commerce ( email )

Rouss and Robertson Halls 125 Ruppel Lane
Charlottesville, VA 22903
United States
(434) 924-7570 (Phone)

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