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The profitability of index futures arbitrage: Evidence from bid‐ask quotes
Author(s) -
Bae KeeHong,
Chan Kalok,
Cheung YanLeung
Publication year - 1998
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/(sici)1096-9934(199810)18:7<743::aid-fut1>3.0.co;2-4
Subject(s) - arbitrage , futures contract , ask price , bid price , economics , database transaction , financial economics , transaction cost , index (typography) , profitability index , risk arbitrage , index arbitrage , futures market , bid–ask spread , business , econometrics , monetary economics , microeconomics , arbitrage pricing theory , finance , computer science , market liquidity , capital asset pricing model , world wide web , programming language
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