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Direct Tests of Index Arbitrage Models

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  • Neal, Robert
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    Abstract

    Previous tests of stock index arbitrage models have rejected the no-arbitrage constraint imposed by these models. This paper provides a detailed analysis of actual S&P 500 arbitrage trades and directly relates these trades to the predictions of index arbitrage models. An analysis of arbitrage trades suggests that i) short-sale rules are unlikely to affect the cash-futures mispricing, ii) the opportunity cost of arbitrage funds exceeds the Treasury bill rate, and iii) the average price discrepancy captured by arbitrage trades is small. Tests of the models provide some support for a version of the arbitrage model that incorporates an early liquidation option. The ability of these models to explain arbitrage trades, however, is surprisingly low.

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    Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

    Volume (Year): 31 (1996)
    Issue (Month): 04 (December)
    Pages: 541-562

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    Handle: RePEc:cup:jfinqa:v:31:y:1996:i:04:p:541-562_02
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    Cited by:

    1. Henker, Thomas & Martens, Martin, 2005. "Index futures arbitrage before and after the introduction of sixteenths on the NYSE," Journal of Empirical Finance, Elsevier, vol. 12(3), pages 353-373, June.
    2. Chen, Haiqiang & Choi, Paul Moon Sub & Hong, Yongmiao, 2013. "How smooth is price discovery? Evidence from cross-listed stock trading," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 668-699.
    3. TUSHAJ Arjin & SINAJ Valentina, 2012. "A Decomposition Of Stock Index Futures Mispricing And The Price Effect Of Index Arbitrage," Studies in Business and Economics, Lucian Blaga University of Sibiu, Faculty of Economic Sciences, vol. 7(2), pages 184-196, August.
    4. Taylor, Nicholas, 2004. "Trading intensity, volatility, and arbitrage activity," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 1137-1162, May.
    5. Tse, Yiuman, 2001. "Index arbitrage with heterogeneous investors: A smooth transition error correction analysis," Journal of Banking & Finance, Elsevier, vol. 25(10), pages 1829-1855, October.
    6. Lucio Sarno & Giorgio Valente & Hyginus Leon, 2006. "Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle," Review of Finance, European Finance Association, vol. 10(3), pages 443-482, September.
    7. Bertus, Mark & Godbey, Jonathan & Hinkelmann, Christoph & Mahar, James W., 2008. "Noise, equity prices, and hedging: A new approach," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 886-902, December.
    8. Garrett Ian & Taylor Nicholas, 2001. "Intraday and Interday Basis Dynamics: Evidence from the FTSE 100 Index Futures Market," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 5(2), pages 1-22, July.
    9. Bialkowski, Jedrzej & Jakubowski, Jacek, 2008. "Stock index futures arbitrage in emerging markets: Polish evidence," International Review of Financial Analysis, Elsevier, vol. 17(2), pages 363-381.
    10. Joseph K.W. Fung, 2006. "Order Imbalance and the Pricing of Index Futures," Working Papers 132006, Hong Kong Institute for Monetary Research.
    11. Joseph K.W. Fung & Philip Yu, 2007. "Order Imbalance and the Dynamics of Index and Futures Prices," Working Papers 072007, Hong Kong Institute for Monetary Research.
    12. Janchung Wang, 2010. "Short Selling and Index Arbitrage Profitability: Evidence from the SGX MSCI and TAIFEX Taiwan Index Futures Markets," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 46(5), pages 48-66, September.
    13. repec:dau:papers:123456789/7689 is not listed on IDEAS
    14. Tu, Anthony H. & Hsieh, Wen-Liang G. & Wu, Wei-Shao, 2016. "Market uncertainty, expected volatility and the mispricing of S&P 500 index futures," Journal of Empirical Finance, Elsevier, vol. 35(C), pages 78-98.

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