Measuring the Impacts of Cash Settlement: A Stochastic Volatility Approach

Posted: 30 Jul 2002

See all articles by Leo H. Chan

Leo H. Chan

Woodbury School of Business, Utah Valley University

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Multiple version iconThere are 2 versions of this paper

Abstract

Prior to 1986, any opening position on feeder cattle futures contract must be settled with physical delivery after the last trading day. Due to dwindling commercial interests, Chicago Mercantile Exchange (CME) subsequently replaced the system with the cash settlement method. It was argued that cash settlement would help improve the convergence between cash and futures prices and reduce the basis variability. In this paper, we adopted stochastic volatility models to investigate this conjecture. The models allow for time varying volatility. We found strong evidence of reduction in basis and in basis variance after cash settlement. Moreover, cash settlement induced a change in the structural relationship between cash and futures prices. The futures market has become more efficient after the change in settlement methods.

Keywords: Stochastic Volatility Model, Quasi-Maximum Likelihood, Cash Settlement, Feeder Cattle Futures Contract

JEL Classification: G1, Q1, C1

Suggested Citation

Chan, Leo H. and Lien, Donald, Measuring the Impacts of Cash Settlement: A Stochastic Volatility Approach. International Review of Economics and Finance, Vol. 11, No. 3, pp. 251-263, 2002. Available at SSRN: https://ssrn.com/abstract=320803

Leo H. Chan (Contact Author)

Woodbury School of Business, Utah Valley University ( email )

Department of Finance and Economics
800 West University Parkway
Orem, UT 84058
United States
801-863-8428 (Phone)

Donald Lien

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

Register to save articles to
your library

Register

Paper statistics

Abstract Views
664
PlumX Metrics