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Liquidity and the Law of One Price: The Case of the Futures‐Cash Basis

Roll, Richard and Schwartz, Eduardo and Subrahmanyam, Avanidhar (2007) Liquidity and the Law of One Price: The Case of the Futures‐Cash Basis. Journal of Finance, 62 (5). pp. 2201-2234. ISSN 0022-1082. doi:10.1111/j.1540-6261.2007.01273.x.

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Deviations from no‐arbitrage relations should be related to market liquidity, because liquidity facilitates arbitrage. At the same time, a wide futures‐cash basis may trigger arbitrage trades and, in turn, affect liquidity. We test these ideas by studying the dynamic relation between stock market liquidity and the index futures basis. There is evidence of two‐way Granger causality between the short‐term absolute basis and liquidity, and liquidity Granger‐causes longer‐term absolute bases. Shocks to the absolute basis predict future stock market liquidity. The evidence suggests that liquidity enhances the efficiency of the futures‐cash pricing system.

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Additional Information:© 2007 the American Finance Association. First published: 04 September 2007. We are grateful to an anonymous referee, an associate editor, and Rob Stambaugh (the editor) for insightful and constructive suggestions that have greatly improved this paper. We also thank Nihat Aktas, Yakov Amihud, Eric de Bodt, Laura Frieder, Terry Hendershott, Esa Jokivuolle, Andrew Karolyi, Alexander Kempf, Olaf Korn, Feifei Li, Jun Liu, and participants in seminars at the University of California—Berkeley, the University of Minnesota, ISCTE Business School in Lisbon, and the UCLA Alumni Association seminar in Tokyo for helpful comments and/or assistance with the preparation of the manuscript.
Issue or Number:5
Record Number:CaltechAUTHORS:20190503-130118576
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Official Citation:ROLL, R. , SCHWARTZ, E. and SUBRAHMANYAM, A. (2007), Liquidity and the Law of One Price: The Case of the Futures‐Cash Basis. The Journal of Finance, 62: 2201-2234. doi:10.1111/j.1540-6261.2007.01273.x
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:95206
Deposited By: Tony Diaz
Deposited On:03 May 2019 20:11
Last Modified:16 Nov 2021 17:11

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