Finance

This paper provides a rationale for markets in baskets of securities (e.g. the stock index futures markets) by demonstrating that they provide a convenient trading medium for liquidity traders. The reason advanced is that the transaction costs suffered by these liquidity traders due to adverse trades with informed traders will typically be lower in markets for baskets than in markets for individual securities. The paper implies that large financial institutions may be expected to trade heavily in baskets to satisfy the liquidity needs of their clients. Thus, the paper provides a plausible explanation for the remarkable growth in the popularity of the stock index futures market over the past few years