Spot and Forward Prices in the Brussels SE: Time Value v. Convenience Premiums
34 Pages Posted: 16 Feb 2009
Date Written: February 16, 2009
Until the mid-90s, the more active among the Brussels-listed stocks were traded in two parallel segments: "spot'' (that is, with (t 3) settlement) and "forward'' (periodic settlement at the end of a two- or three-week period). In this paper we study the opening prices from the angle of what drives the observed forward premiums. We test whether forward premiums are related to time to settlement and interest rates, and, if not, whether they seem to reflect extra costs (or shadow costs) of running out of either cash balances or long stock positions.
The settlement effect is tested in each market separately and then on cross-market price differences. In spot markets there is very little evidence in favor or against a settlement effect, perhaps because the time value item has a very small variability. As expected, the time value signals are somewhat stronger in forward prices and noticeably so in forward premiums, but the estimates remain below our theoretical priors.
Next, we show theoretically that a positive forward premium is more likely in a situation in which the order volume from cash-constrained buyers exceeds that of sellers without a long position. Likewise, a negative forward premium typically means that the order volume from sellers without long positions exceeds that of cash-constrained buyers. We find that abnormally high forward premiums are 2.5-3 times more frequent and larger than negative premiums, and that they persist in time, unlike negative premiums. Thus, contrary to what many academics may have expected, getting money loans seems to be a more frequent, more expensive, and more persistent problem than asset borrowing.
Keywords: dual markets, settlement effect, market microstructure
JEL Classification: G14, G15
Suggested Citation: Suggested Citation