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R. Tarantino, “Arbitrage and Implied Price Relationships among the S&P500 Cash Index, SPDRs, and Futures,” (Honors thesis, New York University, May 2004).

R. Tarantino, “Arbitrage and Implied Price Relationships among the S&P500 Cash Index, SPDRs, and Futures,” (Honors thesis, New York University, May 2004).

Abstract: This paper examines the spot-futures pricing and arbitrage relationships by using both the SPDR and the S&P 500 cash index as the “underlying cash asset.” Conceptually the S&P 500 futures should track the basket of stocks in the index, based on their weights in the index. However, using such a portfolio is expensive. Using the SPDR as the cash asset examines whether a liquid tradable single asset can be used for pricing and arbitrage purposes. We also use futures volume data to identify whether sufficient trading exists to execute a strategy at a given arbitrage price to exploit any futures mis-pricings. The analysis examines how long mis-pricing lasts and the impact of volatility on mis-pricing. Our results show that mis-pricings exist regardless of the choice of underlying asset. We find more negative mis-pricings using the SPDR and more positive mis-pricings using the S&P 500 cash index, but the former disappear more rapidly as the size of transactions costs is increased. Furthermore, we find that mis-pricings are far more frequent in high volatility months than in low volatility months, but the length of time that a mis-pricing exists and the associated volume appear to be unrelated to the monthly level of volatility.