We argue that deviations from the law of one price between futures and spot prices, known as bases, capture important information about liquidity demand for equity market exposure in global equity index futures markets. We show that bases (1) co-move with dealer and investor futures positions, (2) are contemporaneously positively correlated with spot and futures markets with the same sign, and (3) negatively predict futures and spot market returns with the same sign. These findings are uniquely consistent with our liquidity demand model and distinct from other explanations for bases, such as arbitrage opportunities or intermediary balance sheet costs. We show persistent supply-demand imbalances for equity index exposure reflected in bases, where compensation for meeting liquidity demand for that exposure is large (5-6% annual premium).

An empirical puzzle in financial markets is that riskier assets earn lower risk-adjusted returns than less risky assets. Theories seeking to explain this phenomenon focus either on market frictions, such as leverage costs, or non-traditional preferences for lottery-like payoffs. We relate the low risk anomaly to the Favorite-Longshot Bias in betting markets, where returns for betting on riskier "longshots" are lower than betting on "favorites." We synthesize the evidence from both settings and study their joint implications. A key insight is that rational theories of risk-averse investors with homogeneous beliefs facing market frictions cannot explain the cross-sectional relationship between diversifiable risk and return in betting markets. Evaluating preferences versus belief-based explanations, we conclude that preferences likely play a dominant role. Specifically, our evidence points to Cumulative Prospect Theory preferences as a unifying explanation for the facts in both markets, with quantitative calibrations in the betting data matching those used to explain financial market phenomena.