Back to Basis: A Universal Return Predictor Across Asset Classes

Abstract

This paper shows analytically that the basis between spot and futures contracts contains information about future returns of securities across the asset classes of commodities, equity indices, fixed income and foreign exchange. The bases in commodities are positively correlated with a leading indicator of the business cycle whereas the bases in the financial assets are negatively related to the short-term rate. The return predictability of the basis can be captured with a simple multi-asset long-short strategy which produces an out-of-sample Sharpe ratio of 0.5 and an alpha of 2.5%-4.5% per annum with respect to commonly used asset pricing models. Specifically, the analysis includes five Fama-French Factors, a bond index and futures risk premia of multi-asset momentum, value, time-series momentum, and four asset-specific carry factors. The strategy performance is counter-cyclical and robust to transaction costs.

Keywords: return predictability, basis, futures markets

JEL Classification: G1, G11, G150