The present study examines the arbitrage efficiency of the Indian equity futures market over the sample period June 2000 to December 2005. The results suggest that although stable and strong long-run relationship exists between futures and cash markets but futures show significant deviations from its cost-of-carry price, which offers exploitable arbitrage opportunities to the traders. Mispricing has been observed to be a direct function of time-to-maturity, stochastic behavior of interest rates, short sales restriction in the cash market, information asymmetry in both futures and cash markets and restricted exposure of institutional traders to the futures market. Moreover, basis shows significant mean reverting behavior, which indicates that early liquidation option as suggested by Neal (1996) may be helpful in improving the price discovery efficiency in futures as well as cash markets.
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