ersistent discrepancies between implied forward rates on the yield curve P and corresponding futures rates have been widely observed. For instance, in one of our samples, eight week-ahead forward-future spreads averaged nearly 70 discount basis points before 1982 and have since averaged about 30 basis points (see Figure ). Spreads of these magnitudes are usually rationalized as manifestations of market inefficiencies or transactions cost. However, the observation that the spreads are at least predominantly positive' suggests something more is at work.
The observations above appear curious given the presence of leveraged investors (such as securities dealers). securities dealers who seem unlikely to behave inefficiently, are subject to low transactions cost. Assuming they act efficiently, the explanation for substantial forward-futures spreads must be found in the terms at which securities dealers can borrow and lend in order to set up arbitrage positions.
As we shall demonstrate, it is these terms which appear to "drive" (i.e., explain the existence and magnitude of) forward-futures spreads. The market requires there be a positive spread between the dealer rep0 rate over the riskfree Treasury bill rate for the same term (the financing cost spread). Further, this spread will systematically determine the size of the forward-futures spread. We find that the predictive power of the financing cost spread is substantial, despite deficiencies in our database which consists of daily averages for repos and Treasury bills and closing prices for futures. This database is, in part, inferior to those using intra-day prices (notably that of Elton, Gruber, and Rentzler (1984)* but has an advantage over this and other studies in that it 'In the case of the spreads calculated for Figure , and for those appearing later in this paper, a total of 100 calculated forward minus futures spreads, there are only eight negative ones, whose maximum absolute value is eight discount basis points (see Table ). Since the data used in this paper are approximative, (see footnote 12). even these exceptions could easily be due to data error. 21ntra-day prices are not available for term repurchase agreements.