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The introduction of the S&P Depository Receipt (SPDR) in 1993 was a financial innovation that produced several ripple effects in the financial markets. Not only did it allow the small investor to purchase a piece of the S&P 500 Cash Index, it would allow the large investor to utilize the security for arbitrage opportunities with the S&P 500 futures. A theoretical model of arbitrage opportunities utilizing SPDR is developed. The theoretical model provides two outcomes. First, the adoption of the SPDR as an arbitrage tool depends on transaction and liquidity costs and second, the innovation could potentially reduce the traditional mispricing boundary. Due to differences in trading periods between the S&P 500 Cash Index, the S&P 500 Futures Contract, and the SPDR, end-of-day data can be utilized to identify linkages between the three securities. Pricing linkages will occur between the S&P Futures and the SPDR when the SPDR market matures enough to be an effective tool in arbitrage pricing. Pricing data from 1994 to 2001 indicates that it took three years before the SPDR was utilized in arbitrage decisions and four years before the innovation impacted the mispricing boundary.


This article originally published in Investment Management and Financial Innovations, Vol. 2, 2005, pp. 72-82.