settlement tax and non synchronous effects in the basis of u k stock index futures abstract the basis in stock index futures markets is analytically and empirically studied in this paper within a no arbitrage cost of carry framework explanatory power improved when the implications of the u k stock exchange settlement system were introduced into the modelling process and until recently with the maturity of the market evidence indicating the presence of non synchronicities between the cash and futures markets was found strong evidence for tax effects upon the basis was not found to be present in the data analysed statistically significant relationships between basis mispricing and volume and volatility were found

the distribution of daily stock returns and settlement procedures the paris bourse in many countries settlements take place a fixed number of business days after the transaction u s japan in other countries settlements take place periodically on a fixed date when all transactions performed before this date are settled u k france italy in both cases settlement procedures should cause returns not to be identically distributed over all days the effect is likely to be the largest on markets where all trades are settled only once a month an empirical investigation of the largest of those markets the paris bourse demonstrates the importance of the settlement procedure on the distribution of daily returns settlement procedures vary considerably across national stock markets in many countries settlements take place a fixed number of business days after the transaction these countries are referred to in this paper as countries with a fixed settlement lag in other countries settlements take place periodically on a fixed date and all transactions performed before this date are settled then these countries are referred to as countries with a fixed settlement date in both cases settlement procedures should cause returns not to be identically distributed over all days

one security many markets determining the contributions to price discovery when homogeneous or closely linked securities trade in multiple markets it is often of interest to determine where price discovery the incorporation of new information occurs this article suggests an econometric approach based on an implicit unobservable efficient price common to all markets the information share associated with a particular market is defined as the proportional contribution of that market s innovations to the innovation in the common efficient price applied to quotes for the thirty dow stocks the technique suggests that the preponderance of the price discovery takes place at the new york stock exchange nyse a median 92 7 percent information share although most of the classic paradigms in market microstructure concern a security that trades in a single centralized market such situations are becoming increasingly rare in practice fragmentation the dispersal of trading in a security to multiple sites has emerged as a dominant institutional trend this process is of concern to financial economists and regulators because price information and price discovery the impounding of new information into the security price arguably the most important products of a security market have many attributes of public goods as the process of fragmentation accelerates it may be important to determine where the price information and price discovery are being produced 1 this paper suggests a practical econometric approach to this problem the technique is illustrated with an application to u s equity markets many stocks listed on the new york stock exchange nyse trade concurrently on the regional exchanges and the national association of securities dealers national market system nasd nms since a share of ibm stock is the same security whether purchased on the midwest or pacific exchange this is a particularly clear instance of multiple markets nevertheless the expres

a mechanism design approach to climate change agreements we take a mechanism design perspective to investigate how environmental agreements should account for multilateral externalities incentive compatibility and voluntary participation by sovereign countries the optimal mechanism involves a tradeoff between a free rider problem in the effort provision of participating countries and the necessity of inducing countries to ratify the agreement this mechanism can be approximated by a simple menu with attractive implementation and robustness properties limits on enforcement and commitment might nevertheless hinder the performance of this menu making the business as usual scenario more likely

tax arbitrage restrictions and financial leverage clienteles abstract this paper argues that while total short sale constraints are often introduced to rule out tax arbitrage such constraints are both unrealistic and conceptually problematic instead milder constraints are advocated which prevent tax arbitrage while still allow short positions it is demonstrated that a model with these constraints employed can support bond pricing as in the miller equilibrium although it leads to a richer set of tax clienteles

stock volatility and the levels of the basis and open interest in futures contracts this article tests a theoretical model of the basis and open interest of stock index futures the model is based on the differences between stock and futures in terms of investors ability to customize stock portfolios and liquidity empirical evidence confirms the model s prediction that increased volatility decreases the basis and increases open interest copyright 1995 by american finance association

another day another collar an evaluation of the effects of nyse rule 80a on trading costs and intermarket arbitrage in 1990 the new york stock exchange amended its rule 80a to restrict stock index arbitrage on days of large price movements the authors find that rule 80a significantly curtails or collars index arbitrage activity in spite of this curtailment in index arbitrage volume they find that rule 80a appears to have had little overall impact on trading costs and intermarket linkage although pricing discrepancies between the markets do appear to be eliminated less quickly the authors results are consistent with the hypothesis that information is conveyed from one market to the other by means other than formal arbitrage copyright 1998 by university of chicago press

portfolio serial correlation and nonsynchronous trading common stock portfolios of large heavily traded firms exhibit daily first order serial correlation in excess of what would be expected given the individual security coefficients further this correlation rises as the number of securities in the portfolio increases the direct implication of this finding is that nonsynchronous trading is not the only cause of correlation in daily market indices related implications are also discussed

default premiums in commodity markets theory and evidence we model the effect of nonperformance risk on forward and futures pricing and look for evidence of nonperformance risk in precious metals futures prices from the hunt brothers episode changes in default premiums are measured and related to the sequence of events in the metals markets during this period results suggest first that ex ante costs of nonperformance can be a significant priced factor in commodity markets and second that the arrival of new information is often associated with changes in these costs the evidence has implications for both theoretical and empirical research on commodity markets organized commodity markets offer traders an efficient medium in which to execute their hedging and speculative strategies in particular the markets have developed mechanisms that reduce the costs of nonperformance which would be substantial in the absence of an organized exchange devices such as margin requirements position limits daily marking to market price limit moves and the clearinghouse reduce the expected costs of distress and default in commodity markets while organized exchanges greatly reduce expected costs of nonperformance they do not eliminate such costs throughout the history of organized futures trading there have been many instances of markets collapsing or coming to the brink of collapse after a period of unusual trading activity the most prominent example in recent times is the near collapse of the new

a transactions data test of stock index futures market efficiency and index arbitrage profitability this paper investigates the efficiency of the market for stock index futures and the profitability of index arbitrage for the chicago board of trade s major market index contracts the spot value of the index is computed with transactions prices for the component shares of the index obtained from the fitch database the tests account for transaction costs execution lags and the uptick rule for short sales of stocks results indicate that the size and frequency of boundary violations are substantially smaller than those reported by earlier studies and have declined sharply with time index arbitrage is a strategy whereby institutions brokerage houses or other large investors seek to profit from the spread between prices in the spot and futures markets for stock indices for example an investor might purchase predetermined baskets of stocks on the floor of the new york stock exchange and simultaneously sell a related index futures contract on the floor of the chicago board of trade hoping to profit from the price differences on the two exchanges computer programs constantly monitor stock and futures prices and automatically execute buy and sell orders when it appears that a profit is possible stock index futures can be priced by a simple arbitrage argument if the dividends paid by the underlying basket of shares and interest rates are nonstochastic markets are perfect and there are no taxes the pricing equation is

debt and taxes a multiperiod investigation abstract this paper extends the miller bond market equilibrium analysis to a multiperiod setting from the model developed we derive several predictions relating optimal financial leverage to firm characteristics and to the business cycle the analysis also reveals some interesting determinants of the market value of the tax subsidy associated with corporate debt

multilateral externalities contracts with private information either about costs or benefits abstract this note uses the framework of martimort and sand zantmann 2013 forthcoming about international environmental agreements the objective is to demonstrate how a shift of private information from cost to benefit affects contracts and permit market outcomes although this seemingly ad hoc choice has no effect outside contracts and absent market interventions

solving the global warming problem beyond markets simple mechanisms may help his paper discusses the feasibility and performances of simple mechanisms to implement international environmental agreements in the multilateral externalities context of global warming asymmetric information and voluntary participation by sovereign and heterogeneous countries are key constraints on the design of those agreements mechanisms must prevent two sorts of free riding problems free riding in effort provision and free riding in participation as markets might fail to solve simultaneously those two problems we construct instead a simple menu of options that trades off the provision of incentives for participating countries and the provision of incentives to participate with such a mechanism all countries voluntarily contribute to a fund although at different intensities but only the most efficient ones effectively reduce their pollution below its business as usual level

climate cooperation with technology investments and border carbon adjustment a central question in climate policy is whether early investments in low carbon technologies are a useful first step towards a more effective climate agreement in the future we introduce a climate cooperation model with endogenous r d investments where countries protect their international competitiveness via border carbon adjustments bca bca raises the scope for cooperation and leads to a non trivial relation between countries prior r d investments and participation in the coalition we find that early investments in r d render free riding more attractive therefore with delayed cooperation on emission abatement and ex ante r d investments the outcome is often characterized by high participation but inefficiently low technology investments and abatement

risk returns and values in the presence of differential taxation abstract we show that there exist separate security market lines smls for debt and equity securities in an equilibrium with differential taxation of debt and equity we characterize the conditions under which these smls have the same price of risk with different intercepts and the conditions under which the tax effect of leverage is linear in debt value as in the adjusted present value method we explore the implications of our results for cost of capital calculations how to calculate the cost of capital for debt and equity and how to unlever betas correctly accounting for differential taxation

price discovery and volatility spillovers in index futures markets some evidence from mexico abstract this paper investigates the hypotheses that the recently established mexican stock index futures market effectively serves the price discovery function and that the introduction of futures trading has provoked volatility in the underlying spot market we test both hypotheses simultaneously with daily data from mexico in the context of a modified egarch model that also incorporates possible cointegration between the futures and spot markets the evidence supports both hypotheses suggesting that the futures market in mexico is a useful price discovery vehicle although futures trading has also been a source of instability for the spot market several managerial implications are derived and discussed

the design of transnational public good mechanisms for developing countries we analyze the design of incentive mechanisms for the provision of transnational public goods under asymmetric information transnational public goods are infrastructures that no single country can afford to build for itself we show that the external constraints imposed by this mechanism may affect consumption pricing and the true redistributive concerns of local governments we characterize the corresponding distortions we also discuss the impact of the preferences for redistribution of the international agency in charge of designing the mechanism and the role of its ability to enforce that mechanism

friction in the trading process and the estimation of systematic risk abstract this paper considers how estimates of the market model beta parameter can be biased by friction in the trading process information decision and transaction costs that a leads to a distinction between observed and true returns b causes observed returns to be generated asynchronously for a set of interdependent securities and c thereby introduces serial cross correlation into security returns several propositions are derived from which consistent estimators of beta are obtained and the effect of differencing interval length on beta estimates is specified the formulation is contrasted with the related analyses of scholes williams 1977 and dimson 1979

the dynamics of stock index and stock index futures returns in rational efficiently functioning markets the returns on stock index and stock index futures contracts should be perfectly contemporaneously correlated this study investigates the time series properties of 5 minute intraday returns of stock index and stock index futures contracts and finds that sp however the effect is not completely unidirectional with lagged stock index returns having a mild positive predictive impact on futures returns

general equilibrium stock index futures prices theory and empirical evidence we develop a closed form general equilibrium model of stock index futures prices in a continuous time economy with stochastic interest rates and market volatility we show that futures prices implied by the model have very different properties from those of the cost of carry model using nyse stock index futures data we examine the restrictions imposed on futures prices by both the equilibrium and cost of carry models consistent with the equilibrium model we find that stock index futures prices are related to market volatility and that their interest rate sensitivity is a nonlinear function of contract maturity

one market stocks futures and options during october 1987 we provide new evidence regarding the degree of integration among markets for stocks futures and options prior to and during the october 1987 market crash where previous analyses have resulted in recommendations for the implementation of circuit breakers the coordination of margin requirements across markets and changes in regulatory jurisdiction our analysis indicates that delinkage between markets during the crash was primarily caused by an antiquated mechanism for processing stock market orders the results suggest that market integration may be better served by efficient order execution than by further restricting markets

a continuous time equilibrium model of forward prices and futures prices in a multigood economy abstract this paper is a theoretical investigation of equilibrium forward and futures prices we construct a rational expectations model in continuous time of a multigood identical consumer economy with constant stochastic returns to scale production using this model we find three main results first we find formulas for equilibrium forward futures discount bond commodity bond and commodity option prices second we show that a futures price is actually a forward price for the delivery of a random number of units of a good the random number is the return earned from continuous reinvestment in instantaneously riskless bonds until maturity of the futures contract third we find and interpret conditions under which normal backwardation or contango is found in forward or futures prices these conditions reflect the usefulness of forward and futures contracts as consumption hedges

the temporal price relationship between s p 500 futures and the s p 500 index this paper empirically examines the intraday price relationship between s p 500 futures and the s p 500 index using minute to minute data three stage least squares regression is used to estimate lead and lag relationships with estimates for expiration days of the s p 500 futures compared with estimates for days prior to expiration the results suggest that futures price movements consistently lead index movements by twenty to forty five minutes while movements in the index rarely affect futures beyond one minute

arbitrage nontrading and stale prices october 1987 this article explains a puzzle created by the standard and poor s 500 cash and futures prices during the crash of october 1987 the cash index appears to be a moving average of the futures but nontrading in constituent stocks explains only the initial period of delayed openings however execution of stale limit buy orders given the high volume and nyse market mechanisms at the time resulted in extraordinary levels of stock prices that were not caused by nontrading the model is supported in aggregate s p data and transactions data for individual stocks copyright 1992 by university of chicago press

a further analysis of the lead lag relationship between the cash market and stock index futures market the intraday lead lag relation between returns of the major market cash index and returns of the major market index futures and s p 500 futures is investigated empirical results show strong evidence that the futures leads the cash index and weak evidence that the cash index leads the futures the asymmetric lead lag relation holds between the futures and all component stocks including those that trade in almost every five minute interval evidence indicates that when more stocks move together market wide information the futures leads the cash index to a greater degree this suggests that the futures market is the main source of market wide information article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

on the existence of an optimal capital structure theory and evidence one of the most contentious issues in the theory of finance during the past quarter century has been the theory of capital structure the geneses of this controversy were the seminal contributions by modigliani and miller 18 19 the general academic view by the mid 1970s although not a consensus was that the optimal capital structure involves balancing the tax advantage of debt against the present value of bankruptcy costs no sooner did this general view become prevalent in the profession than miller 16 presented a new challenge by showing that under certain conditions the tax advantage of debt financing at the firm level is exactly offset by the tax disadvantage of debt at the personal level since then there has developed a burgeoning theoretical literature attempting to reconcile miller s model with the balancing theory of optimal capital structure e g deangelo and masulis 5 kim 12 and modigliani 17 the general result of this work is that if there are significant leverage related costs such as bankruptcy costs agency costs of debt and loss of non debt tax shields and if the income from equity is untaxed then the marginal bondholder s tax rate will be less than the corporate rate and there will be a positive net tax advantage to corporate debt financing the firm s optimal capital structure will involve the trade off between the tax advantage of debt and various leverage related costs the upshot of these extensions of miller s model is the recognition that the existence of an optimal capital structure is essentially an empirical issue as to whether or not the various leverage related costs are economically significant enough to influence the costs of corporate borrowing the miller model and its theoretical extensions have inspired several timeseries studies which provide evidence on the existence of leverage related costs trczinka 28 reports that from examining differences in average yields between taxable corporate bonds and tax exempt municipal bonds one cannot reject the miller hypothesis that the marginal bondholder s tax rate is not different from the corporate tax rate however trczinka is careful to point out that this finding does not necessarily imply that there is no tax advantage of corporate debt if the personal tax rate on equity is positive indeed buser and hess 1 using a longer time series of data and more sophisticated econometric techniques estimate that the average effective personal tax rate on equity is statistically positive and is not of a trivial magnitude more importantly they document evidence that is consistent with the existence of significant leverage related costs in the economy

program trading and intraday volatility program trading and intraday changes in the s p 500 index are correlated future prices and to a lesser extent cash prices lead program trades index arbitrage trades are followed by an immediate change in the cash index which ultimately reverses slightly no reversal follows nonarbitrage trades the cumulative index changes associated with buy and sell trades and with arbitrage and nonarbitrage trades all are similar price decompositions suggest that the results are not due to microstructure effects program trades in this 1989 1990 sample do not seem to have created major short term liquidity problems the results are stable within the sample many practitioners regulators and public commentators have expressed concerns about potential destabilizing effects of program trading they argue that program trades especially index arbitrage programs increase intraday volatility and decrease

miller s irrelevance mechanism a note this note attempts to clarify miller s 12 capital structure irrelevance mechanism using a geometric edgeworth box diagrams presentation such an exercise is useful because miller s proposition is founded on analytically complex equilibrium arguments that tend to mask the intuition and logic behind his result since miller s original discussion unnecessarily assumed a zero tax on equity income and since miller did not prove his clientele effects rigorously we also focus our attention on the deangelo and masulis 8 9 henceforth d m generalization of the miller model the d m framework is also important because it assumes a proportional tax code as we shall see whether the tax code is proportional or progressive is an important factor in understanding miller s proposition

firm specific information and the correlation between individual stocks and bonds abstract this paper examines the correlation between the returns on individual stocks and the yield changes of individual bonds issued by the same firm and finds that they are negatively and contemporaneously correlated this suggests that individual stocks and bonds are driven by firm specific information that is predominantly related to the mean rather than the variance of the firm s underlying assets furthermore i find that lagged stock returns have explanatory power for current bond yield changes while current stock returns are unrelated to lagged bond yield changes this shows that stocks lead bonds in reflecting firm specific information

arbitrage cointegration and testing the unbiasedness hypothesis in financial markets we use a no arbitrage cost of carry asset pricing model to show that the existence of coin tegration between spot and forward futures prices depends on the time series properties of the cost of carry we argue that the conditions for cointegration are more likely to hold in currency markets than in commodity markets explaining many of the empirical results in the literature we also use this model to demonstrate why the forward rate forecast error the basis and the forward premium are serially correlated and to develop econometric tests ofthe unbiasedness hypothesis sometimes called the simple efficiency hypothesis in various financial markets the unbiasedness hypothesis is so prevalent in the finance liter ature that many tests for it have been developed we examine four of the common tests and and use our cointegration results to demonstrate why each of these tests should reject the null hypothesis of unbiasedness we find strong support for our hypothesis in the existing empirical literature

crises in developed and emerging stock markets stock market crises in the developed markets differ in important ways from the crises in emerging stock markets our study of nine crises in the 1970 97 period indicates that developed market crises have become less severe over time in terms of both the extent of price decline and duration but those in emerging stock markets have not in both markets prices fall for at least three years subsequent to recovery from a crisis and the crisis in one market is likely to be followed by crises in most other markets in the region nevertheless even in times of crises international stocks continue to provide diversification benefits for u s investors with long investment horizons

seasonality estimation in thin markets the greater availability of daily data in the u s has led to a number of studies of the seasonality of daily stock index returns while the studies recognized the potential impacts of nontrading and price adjustment delays in general no formal analyses of such impacts were presented in this paper analytic results are presented for the articulation between these phenomena the implications of the analysis are discussed and shown to be consistent with a sample of u k index data a modified form of the negative weekend effect is found to be present in the u k data analyzed tests for the presence of seasonality in equity returns have been carried out by a number of authors at both the monthly and daily return levels at the monthly level rozeff and kinney 18 discovered evidence of seasonality in the u s while officer 15 detected the presence of seasonality in australian data fama 7 carried out some early work on u s daily data and more recent contributions have been made by cross 5 french 9 and gibbons and hess 10 while these studies recognized the presence of thin trading and its potential impacts upon the experimental results no formal analyses were presented in this paper we derive analytic results for the articulation between seasonality and nontrading effects section i the implications of this analysis are tested using a sample described in section ii of u k daily index data2 in section iii section iv discusses the implications of the results for capital market efficiency finally

information and index arbitrage a random cash futures basis is derived in a dynamic multimarket learning game with sequential information shocks and strategic arbitrageurs who trade to exploit gaps in the basis statistical properties of the authors theoretical basis are derived both with and without index arbitrage the authors find that basis volatility a measure of intermarket mispricing may initially increase even as individual prices become more precise and that arbitrage reduces basis volatility the model is also used to analyze regulatory issues such as the possible impact of circuit breakers on the quality of the trading process copyright 1994 by university of chicago press

measuring true stock index value in the presence of infrequent trading based on the beveridge nelson 1981 decomposition of an arima process i present a measure of true stock index value that is not directly observable due to infrequent trading of stocks the technique is illustrated with daily observations of the russell 2000 index this new measure might well prove useful in studies of lead lag relationships between index derivatives and spot market and futures basis measurements

box spread arbitrage profits following the 1987 market crash real or illusory we examine market efficiency before and after the 1987 market crash using the box spread strategy implemented with european style s p 500 index spx options before the crash apparent arbitrage opportunities were rare and simulated trades were unprofitable assum ing a one minute execution delay after the crash apparent arbitrage opportunities were frequent and simulated trades were profitable even assuming a five minute execution delay our analysis makes the routine assumption that quotes are good until updated to construct a time series of prevailing quotes sampled at 30 second intervals if this assumption is valid then arbitrage profits were actually available if this assumption is invalid then such profits could have been illusory either scenario however implies that spx market effi ciency decreased following the crash prevailing price quotes repeatedly failed to satisfy the fundamental parity relation underlying the box spread

hedging performance and basis risk in stock index futures in early 1982 trading began at three different exchanges in futures contracts based on stock indexes stock index futures were an immediate success and quickly led to a proliferation of new futures and options markets tied to various indexes one reason for this success was that index futures greatly extended the range of investment and risk management strategies available to investors by offering them for the first time the possibility of unbundling the market and nonmarket components of risk and return in their portfolios many portfolio management and other hedging applications in investment banking and security trading have been described elsewhere1 ranging from use by a passive fund manager to reduce risk over a long time horizon to use by an underwriter to hedge the market risk exposure in a stock offering for one or two days in considering the potential applications of index futures it is clear that in nearly every case a cross hedge is involved that is the stock position that is being hedged is different from the underlying portfolio for the index contract 2 this means that return and risk for an index futures hedge will depend upon the behavior of the basis i e the difference between the futures price and the cash price hedging a position in stock will necessarily expose it to some measure of basis risk risk that the change in the futures price over time will not track exactly the value of the cash position basis risk can arise from a number of different sources and is a more significant problem for stock index contracts than for other financial futures like treasury bills and bonds 3 the most apparent cause of basis risk is the nonmarket component of return on the cash stock position since the index contract is tied to the behavior of an underlying stock market index nonmarket risk cannot be hedged this is the essential problem of a cross hedge however basis risk can be present even when the hedge involves a position in the index portfolio itself and there is no nonmarket risk for one thing returns to the index portfolio include dividends while the index and the index future only track the capital value of the portfolio any risk associated with dividends on the portfolio will become basis risk in a hedged position still dividends are fairly low and also quite stable so this may not be a terribly important shortcoming

nonsynchronous security trading and market index autocorrelation the theoretical portfolio autocorrelation due solely to nonsynchronous trading is estimated from a derived model this estimated level is found to be substantially less than that observed empirically the theoretical and empirical relationship between portfolio size and autocorrelation also is investigated the results of this study suggest that other price adjustment delay factors in addition to nonsynchronous trading cause the high autocorrelations present in daily returns on stock index portfolios

intraday relationships among index arbitrage spot and futures price volatility and spot market volume a transactions data test abstract this paper examines intraday temporal relationships among arbitrage spreads cash and futures price volatility and cash trading volume using transactions data for the major market index futures contracts and the component stocks of the index results indicate that changes in the spread have a significant impact on cash and futures price volatility as well as on cash trading volume the impact of the spread however is attenuated by the short sale restriction in the cash market contrary to popular beliefs a more volatile market leads to subsequent decreases in the spread probably because of increases in the supply of arbitrage services or faster price adjustments

intraday volatility in the stock index and stock index futures markets we examine the intraday relationship between returns and returns volatility in the stock index and stock index futures markets our results indicate a strong intermarket dependence in the volatility of the cash and futures returns price innovations that originate in either the stock or futures markets can predict the future volatility in the other market we show that this relationship persists even during periods in which the dependence in the returns themselves appears to weaken the findings are robust to controlling for potential market frictions such as asynchronous trading in the stock index our results have implications for understanding the pattern of information flows between the two markets article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

the puzzle of financial leverage clienteles empirically it appears that common stock of publicly traded corporations with high debt ratios tends to be held by investors with relatively low marginal taxes while the stock in companies with little debt is held by investors in high tax brackets a number of authors have argued that in an equilibrium similar to the one described by miller 8 these clienteles should exist we argue that standard portfolio theory does not imply financial leverage clienteles for publicly traded firms we explain the empirical relationship between investor tax rates and leverage ratios by the existence of dividend clienteles and a positive relationship between dividend yield and leverage ratios

tax arbitrage and the existence of equilibrium prices for financial assets in models where both investors and securities are subject to differential taxation there may be no set of prices that rule out infinite gains to trade or tax arbitrage this paper characterizes the joint restrictions on financial asset returns and investors tax schedules that preclude tax arbitrage in the absence of short sale constraints the authors show that if there exists any configuration of marginal tax rates on investors tax schedules that rule out infinite gains to trade then no tax arbitrage prices will exist they also show that the existence of no tax arbitrage prices ensures the existence of equilibrium prices the effects of differential taxation on the equilibrium prices of financial assets have attracted much attention from financial economists in recent years otherwise identical securities that contribute to taxable income to different degrees will in general be valued differently by taxable investors as a result tax considerations have been useful in helping explain the effect of dividend yield on stock returns the effect of coupon levels and term to maturity on bond prices 2 the timing of investors portfolio transactions 3 and the observed capital structures of firms 4 while a rich set of observed behaviors can be better understood by reference to differential taxation there are well known difflculties in dealing with taxes in a general equilibrium setting to clear markets relative prices must reflect the marginal rates of substitution of all agents simultaneously when tax rates differ across investors however this condition can be impossible to achieve to illustrate consider a world of perfect certainty with two assets a tax exempt municipal bond and a taxable government bond to equate marginal rates of substitution the rate of return on the government bond rg must equal that on the municipal rm grossed up by one minus the investor s marginal tax rate ti that is rg rm 1 ti if there are investors in more than one tax bracket this condition will obviously be impossible to satisfy for all of them simultaneously both authors from graduate school of industrial administration carnegie mellon university we wish to thank scott richard steven spear and an anonymous referee for helping us sort through the issues considered here seminar participants at columbia wharton the johnson symposium on asset pricing at the university of wisconsin madison and the 1986 western finance association meeting also provided valuable comments we are also grateful for the financial support provided by the center for public policy research carnegie mellon university all errors are our own responsibility

stock index futures does the tail wag the dog the increase in program trading based on a comparatively narrow blue chip stock market barometer the major market index mmi is said to be fueling volatile price swings in the stock market a case of the tail wagging the dog the mmi is a price weighted index of 20 very actively traded stocks 16 of which are included in the dow jones 30 industrials because of its relatively small size the mmi is expected to be more easily arbitragible than other stock index futures contracts basically program trading involves taking a position long or short in a portfolio of stocks comprising the index and simultaneously taking an opposite position in the index futures contracts the objective of the program trade is to create a risk free position that earns a return in excess of the currently available risk free return program trades may move both the futures and the spot market the chain of causality may work as follows 1 investors believe the stock market will rise and they purchase futures contracts in expectation of higher equity values the purchase of the contracts is preferable to the purchase of the underlying stocks because it entails no initial investment and lower transaction costs 2 the rise in futures prices causes an imbalance between the prices of the futures and the underlying index as this premium between futures and index increases it may become profitable to execute a program trade 3 the simultaneous sale of futures and purchase of the underlying index will cause the premium between the futures and index to shrink changes in factors such as interest rates can also affect the equilibrium relation between the index price and the futures price thereby changing the premium or discount between the two markets program traders can take advantage of any change in the spread between the markets it does not matter what causes the change in spreads whether internal factors such as changes in investor expectations or external factors such as interest rate changes all program trading does is to bring cash and futures prices together the program trade may be an essential mechanism that ensures that futures prices and underlying equity prices are efficiently determined and that the hedging effectiveness of the futures contracts is reliable to date most of the literature on the impact of futures trading on the cash market has focused on changes in spot price volatility because of the initiation or cessation of futures trading a common conclusion of these studies is that the futures market has a smoothing effect on the cash market stabilizing the spot price the recent uproar engendered by the triple witching hour and the so called crises at expiration brings into question the smoothing influence that futures have on the underlying index 2 if the market is efficient prices adjust instantaneously to reflect all relevant information and knowledge of such information cannot lead to excess risk adjusted returns the central concept in the efficient market hypothesis is the fair game model 3 a sequence of past returns over time is a fair game if today s price reflects the then available information making it impossible to earn excess risk adjusted returns by trading on that information if the information set today contains all the information known and used by the market participants in the spot market in determining the spot price one of the components of the information set is the previous change in the price of futures contracts 4 does the tail wag the dog the financial press and the sec have answered this question in the affirmative 5 this note investigates the impact of the futures market on the spot market by evaluating the relation between index futures price changes and subsequent spot index price changes in addition we evaluate the degree to which the expiration of the futures contract affects the underlying index

index futures arbitrage and the behavior of stock index futures prices this article examines intraday transaction datafor s p 500 stock indexfutures prices and the intraday quotes for the underlying index the data indicate that thefutures price changes are uncorrelated and that the variability of these price changes exceeds the variability ofprice changes in the s p 500 index this excess variability of the futures over the index remains even after controlling for the nonsynchronous prices in the index quotes which induces autocorrelation in the index changes we advance and examine empirically two hypotheses regarding the difference between the futures price and its theoretical value that this mispricing increases on average with maturity and that it is path dependent evidence supporting these hypotheses is presented

the critical implicit tax rate and capital structure in a miller world firms are indifferent between debt and equity when the tax rate that isimplicitly used to price a bond is equal to the statutory corporate tax rate in this paper we derive the implicit tax rate that makes a firm marginally indifferent between debt and equity when debt related tax savings are uncertain we analyze the functional relationship between this critical tax rate and the amount of debt issued by a firm and discuss the implications for a firm s optimal capital structure

order imbalances and stock price movements on october 19 and 20 1987 on october 19 1987 nyse stocks in the s p index declined seven percentage points more than nyse stocks not in this index in the first hour of trading on october 20 the s p stocks virtually recovered to the level of the non s p stocks there is a strong relation between order imbalances and stock price movements both in analyses of time series and cross sections thus in addition to the breakdown in the linkage between future prices and the spot index on these two days there were also breakdowns in the linkage among nyse stocks

taxes and the pricing of stock index futures stock index futures prices are generally below the level predicted by simple arbitrage models this paper suggests that the discrepancy between the actual and predicted prices is caused by taxes capital gains and losses are not taxed until they are realized as constantinides demonstrates in a recent paper this gives stockholders a valuable timing option if the stock price drops the investor can pass part of the loss on to the government by selling the stock on the other hand if the stock price rises the investor can postpone the tax by not realizing the gain since this option is not available to stock index futures traders the futures prices will be lower than standard no tax models predict on 24 february 1982 the kansas city board of trade began trading futures contracts on the value line average stock index during the next two months both the chicago mercantile exchange and the new york futures exchange also initiated trading in stock index futures although these contracts are actively traded their prices have puzzled both practitioners and academics the observed

mean reversion of standard poor s 500 index basis changes arbitrage induced or statistical illusion mean reversion in stock index basis changes has been presumed to be driven by the trading activity of stock index arbitragers we propose here instead that the observed negative autocorrelation in basis changes is mainly a statistical illusion arising because many stocks in the index portfolio trade infrequently even without formal arbitrage reported basis changes would appear negatively autocorrelated as lagging stocks eventually trade and get updated the implications of this study go beyond index arbitrage however our analysis suggests that spurious elements may creep in whenever the price change or return series of two securities or portfolios of securities are differenced mean reversion in stock index basis changes has been amply documented mackinlay and ramaswamy 1988 find significant negative first order autocorrelation in normalized intraday basis changes of the s p 500 index futures traded on the chicago mercantile exchange cme yadav and pope 1990 find similar behavior using financial times stock exchange ftse 100 index futures data from the london international financial futures exchange liffe as does lim 1990 using nikkei 225 index futures from the singapore international monetary exchange simex the trading activity of stock index arbitragers has been presumed to be driving this elastic realignment of stock index and index futures prices when the basis widens beyond its theoretical level arbitragers simultaneously sell index futures and buy the index portfolio pulling the difference between the futures and index

asymmetric information bargaining problems with many agents a yes or no decision must be made about some issue all agents must agree the coase theorem asserts that the efficient outcome will always result suppose the value positive or negative that an individual attaches to an affirmative decision is privately known to that individual it is proved under very mild conditions that with independent types as the number of agents increases the probability of an affirmative efficient decision goes to zero an example in which it is common knowledge that an affirmative decision is efficient and yet the probability of such a decision goes to zero is given

the october 1987 s p 500 stock futures basis five minute changes in the s p 500 index and futures contract are examined over a ten day period surrounding the october 1987 stock market crash since nonsynchronous trading problems are severe in these data new index estimators are derived and used the estimators use the complete transaction history of all 500 stocks nonsynchronous trading explains part of the large absolute futures cash basis observed during the crash the remainder may be due to disintegration of the two markets even after adjustment for nonsynchronous trading the index displays more autocorrelation than does the futures and the futures leads the index

direct tests of index arbitrage models 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 cashfutures 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 ofthe arbitrage model that incorporates an early liquidation option the ability of these models to explain arbitrage trades however is surprisingly low

price and volatility co jumps abstract the nature of the dependence between discontinuities in prices and contemporaneous discontinuities in volatility co jumps has been reported by many as being elusive in terms of sign magnitude and statistical significance using a novel identification strategy in continuous time relying on trade level information for spot variance estimation as well as infinitesimal cross moments we document that a sizeable proportion of discontinuous changes in prices are associated with strongly anti correlated contemporaneous discontinuous changes in volatility assuming a possibly nonmonotonic pricing kernel we illustrate the equilibrium implications of price and volatility co jumps for return and variance risk premia

a tale of three schools insights on autocorrelations of short horizon stock returns this article reexamines the autocorrelation patterns of short horizon stock returns we document empirical results which imply that these autocorrelations have been overstated in the existing literature based on several new insights we provide support for a market efficiency based explanation of the evidence our analysis suggests that institutional factors are the most likely source of the autocorrelation patterns

the relation between forward prices and futures prices abstract this paper consolidates the results of some recent work on the relation between forward prices and futures prices it develops a number of propositions characterizing the two prices these propositions contain several testable implications about the difference between forward and futures prices many of the propositions show that equilibrium forward and futures prices are equal to the values of particular assets even though they are not in themselves asset prices the paper then illustrates these results in the context of two valuation models and discusses the effects of taxes and other institutional factors

intraday relationships between volatility in s p 500 futures prices and volatility in the s p 500 index abstract this paper examines the intraday relationships between the volatility of s p 500 futures prices and the volatility of the s p 500 index we calculate variance measures for minute to minute price changes on a daily basis and across 30 minute intervals the empirical results indicate that i futures volatility is greater than index volatility ii volatility increased for both futures prices and the index in absolute terms from 1984 through 1986 iii both futures and index volatility increased directly with futures trading volume and iv index volatility was systematically greater during the first 30 minutes of trading each day than at other times granger tests however reveal no systematic pattern of futures volatility leading index volatility or index volatility leading futures volatility

the interaction of corporate and government financing in general equilibrium this article develops a general equilibrium model for analyzing the in teraction of corporate financial and production decisions consumers behavior and government financing the authors use the model to inv estigate how changes in income tax rates and government debt policy a ffect production interest rates and consumer welfare they also sho w how changes in the different tax rates affect other tax rates in ge neral equilibrium copyright 1988 by the university of chicago