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On the relation between liquidity and the futures-cash basis: Evidence from a natural experiment

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  • Han, Jianlei
  • Pan, Zheyao

Abstract

As a response to the 2015 Chinese stock market crash, regulators prohibited arbitrage activities in the index futures and cash markets. We use this natural experiment to test the hypothesis that liquidity and pricing efficiency causally affect each other. We find that resulting shift in the arbitrage boundary led to the breakdown of the two-way causality relation between liquidity and the absolute futures-cash basis. We thus confirm that the relation between liquidity and the absolute futures-cash basis is not driven by the omitted variable bias, but is indeed due to arbitrage.

Suggested Citation

  • Han, Jianlei & Pan, Zheyao, 2017. "On the relation between liquidity and the futures-cash basis: Evidence from a natural experiment," Journal of Financial Markets, Elsevier, vol. 36(C), pages 115-131.
    • Handle: RePEc:eee:finmar:v:36:y:2017:i:c:p:115-131
    DOI: 10.1016/j.finmar.2016.12.002
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    Cited by:

    1. Wu, Lei & Zeng, Hongchao, 2019. "The impact of liquidity constraints on the cash-futures basis dynamics: Evidence from the Chinese market," Economic Modelling, Elsevier, vol. 83(C), pages 96-110.
    2. Huimin Guo & Zheyao Pan & Gary Gang Tian, 2021. "State ownership and the risk‐reducing effect of corporate derivative use: Evidence from China," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(5-6), pages 1092-1133, May.
    3. Sumit Saurav & Sobhesh Kumar Agarwalla & Jayanth R. Varma, 2024. "Role of derivatives market in attenuating underreaction to left‐tail risk," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(3), pages 484-517, March.
    4. Deng, Xiaohu & Jiang, Christine & Young, Danqing, 2021. "Short selling constraints and politically motivated negative information suppression," Journal of Corporate Finance, Elsevier, vol. 68(C).
    5. Luiz Augusto Magalhães & Thiago Christiano Silva & Benjamin Miranda Tabak, 2022. "Hedging commodities in times of distress: The case of COVID‐19," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(10), pages 1941-1959, October.

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    More about this item

    Keywords

    Futures-cash basis; Liquidity; Trading restrictions; Arbitrage;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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