Bond derivatives markets expanded arbitrage opportunities from the mid 1970s onward

Evidence

From the mid 1970s on, the arbitrage opportunities offered by bonds and mortgage-backed securities were expanded by the emergence of markets in derivatives of these securities. The Chicago Board of Trade began trading futures on mortgage-backed securities in October 1975 and futures on U.S. Treasury bonds in August 1977. Markets also began to develop in derivatives (such as bond options and swaps) sold “over the counter” that is, by direct, institution-to-institution negotiations. (Swaps are contracts to exchange income streams, such as fixed-rate and floating-rate interest on the same notional principal sum.) — Donald MacKenzie, An Engine, Not a Camera, 959

Categorization

• DEFINE: Defines swaps clearly as income-stream exchange contracts, useful reference for the derivative machinery that later underpins LTCM.
• XREF: connects to: Derivative markets grew from near-zero to systemically central in seventeen years — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 31; Arbitrage enforces a real link that anchors derivatives to underlying assets — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 781; The 1987 crash exposed limits of arbitrage as a mechanism linking markets — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 822 (+3 more)

Broader Connections

• The arbitrage argument produces the Black-Scholes partial differential equation. #expands (0.78) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 95
• Arbitrage enforces a real link that anchors derivatives to underlying assets #corroborates (0.75) — Donald MacKenzie, An Engine, Not a Camera, 781
• The 1987 crash exposed limits of arbitrage as a mechanism linking markets #qualifies (0.75) — Donald MacKenzie, An Engine, Not a Camera, 822
• Traders’ arbitrage activity made the pricing model appear empirically true #expands (0.75) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 126
• Arbitrage strategies became consensus trades as hedge funds imitated LTCM #expands (0.72) — Donald MacKenzie, An Engine, Not a Camera, 1029