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The profitability of index futures arbitrage: Evidence from bid‐ask quotes

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  • Kee‐Hong Bae
  • Kalok Chan
  • Yan‐Leung Cheung

Abstract

Previous studies investigated the profitability of stock index futures based on transaction price data, and could overstate the frequency of arbitrage opportunities and size of arbitrage profits. This article obtains a data base for the Hong Kong index futures and index options market that contains both real‐time transaction prices and bid‐ask quotes; the article further examines the bias of identifying arbitrage opportunities based on transaction prices. The article finds the percentage of observations violating no‐arbitrage bounds is significantly reduced when bid‐ask quotes are employed instead of transaction prices. This suggests studies that implement arbitrage strategies based on transaction prices employ prices from the wrong side of the spread. This article finds a relationship between the frequency of violations (evaluated from transaction prices) and the size of bid‐ask spreads in the futures and options markets. This phenomenon indicates that a larger mispricing, which may arise when the bid‐ask spread is wider, does not necessarily imply profitable arbitrage opportunity. © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:743–763, 1998

Suggested Citation

  • Kee‐Hong Bae & Kalok Chan & Yan‐Leung Cheung, 1998. "The profitability of index futures arbitrage: Evidence from bid‐ask quotes," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 18(7), pages 743-763, October.
    • Handle: RePEc:wly:jfutmk:v:18:y:1998:i:7:p:743-763
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    Cited by:

    1. Doojin Ryu & Doowon Ryu & Heejin Yang, 2021. "The impact of net buying pressure on index options prices," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(1), pages 27-45, January.
    2. Joseph K. W. Fung & Henry M. K. Mok & Kenneth C. K. Wong, 2004. "Pricing Efficiency in a Thin Market with Competitive Market Makers: Box Spread Strategies in the Hang Seng Index Options Market," The Financial Review, Eastern Finance Association, vol. 39(3), pages 435-454, August.
    3. Michael S. Haigh, 2005. "Conditional volatility forecasting in a dynamic hedging model," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 24(3), pages 155-172.

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