Liquidity Effects of the Introduction of the S&P 500 Index Futures Contract on the Underlying Stocks.

This study examines bid-ask spreads in the stock market around the introduction of the Standard and Poor's (S&P) 500 index futures contract and tests the following competing hypotheses: (1) stock spreads may widen as uninformed traders migrate to futures and (2) spreads may narrow because specialists can hedge better. The authors' analysis suggests that, after controlling for changes in other spread determinants, average spreads of S&P 500 stocks increased significantly. Though an additional test suggests an increase in the adverse-selection component of the spread in the postfutures period, this increase is not reliably different from zero. Copyright 1993 by University of Chicago Press.