Search Results
Working Paper
Index arbitrage and nonlinear dynamics between the S&P 500 futures and cash
We use a cost of carry model with nonzero transactions costs to motivate estimation of a nonlinear dynamic relationship between the S&P 500 futures and cash indexes. Discontinuous arbitrage suggests that a threshold error correction mechanism may characterize many aspects of the relationship between the futures and cash indexes. We use minute-by-minute data on the S&P 500 futures and cash indexes. The results indicate that nonlinear dynamics are important and related to arbitrage and suggest that arbitrage is associated with more rapid convergence of the basis to the cost of carry than would ...
Journal Article
Arbitrage: the key to pricing options
Arbitrage has become associated in popular attitudes with the most ruthless and profit-driven of human impulses, but the opposite reputation might be more well-deserved. The ability to arbitrage is essential for the efficient operation of markets. An interesting application of the principle of arbitrage arose when it provided the breakthrough insight in economists? solution to a formerly intractable problem: how to properly price the emergent financial instruments known as options.
Working Paper
Deliverability and regional pricing in U.S. natural gas markets
During the 1980s and early '90s, interstate natural gas markets in the United States made a transition away from the regulation that characterized the previous three decades. With abundant supplies and plentiful pipeline capacity, a new order emerged in which freer markets and arbitrage closely linked natural gas price movements throughout the country. After the mid-1990s, however, U.S. natural gas markets tightened and some pipelines were pushed to capacity. We look for the pricing effects of limited arbitrage through causality testing between prices at nodes on the U.S. natural gas ...
Working Paper
Interest on Reserves and Arbitrage in Post-Crisis Money Markets
Currently, Eurodollars and fed funds markets combined trade about $220 billion in funds daily, the vast majority of which with overnight tenor. In this paper, we document several features of these wholesale unsecured dollar funding markets. Using daily confidential data on wholesale unsecured borrowing and reserve balances, we show that foreign banks, which make up most of the trading volumes in these markets, keep around 99% of each additional Eurodollar and 80% of each fed fund borrowed as reserve balances. With these risk-free trades, banks earn the spread between interest on reserves and ...
Working Paper
Arbitrage and Liquidity: Evidence from a Panel of Exchange Traded Funds
Market liquidity is expected to facilitate arbitrage, which in turn should affect the liquidity of the assets traded by arbitrageurs. We study this relationship using a unique dataset of equity and bond ETFs compiled from big trade-level data. We find that liquidity is an important determinant of the efficacy of the ETF arbitrage. For less liquid bond ETFs, Granger-causality tests and impulse responses suggest that this relationship is stronger and more persistent, and liquidity spillovers are observed from portfolio constituents to ETF shares. Our results inform the design of synthetic ...
Working Paper
Arbitrage Capital of Global Banks
We show that the role of unsecured, short-term wholesale funding for global banks has changed significantly in the post-financial-crisis regulatory environment. Global banks mainly use such funding to finance liquid, near risk-free arbitrage positions---in particular, the interest on excess reserves arbitrage and the covered interest rate parity arbitrage. In this environment, we examine the response of global banks to a large negative wholesale funding shock as a result of the U.S. money market mutual fund reform implemented in 2016. In contrast to past episodes of wholesale funding dry-ups, ...
Working Paper
Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis
Hedge fund gross U.S. Treasury (UST) exposures doubled from 2018 to February 2020 to $2.4 trillion, primarily driven by relative value arbitrage trading and supported by corresponding increases in repo borrowing. In March 2020, amid unprecedented UST market turmoil, the average UST trading hedge fund had a return of -7% and reduced its UST exposure by close to 20%, despite relatively unchanged bilateral repo volumes and haircuts. Analyzing hedge fund-creditor borrowing data, we find the large, more regulated dealers provided disproportionately more funding during the crisis than other ...
Working Paper
An international arbitrage pricing model with PPP deviations
This paper develops an intertemporal, international asset pricing model for use in applied theoretical and empirical research. An important feature of the model is that it incorporates both stochastic inflation rates and stochastic Purchasing Power Parity deviations (PPP). The model derives the equilibrium real return on assets, and obtains empirically tractable reduced form equations which can be used to examine such issues as capital market segmentation, currency substitution, exchange rate volatility, and the forward exchange market's risk premium. Mechanically, the model begins as a ...