Using High, Low, Open and Closing Prices to Estimate the Effects of Cash Settlement on Futures Prices

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 reduces the futures price's volatility. In this paper, we adopted stochastic volatility models to investigate this conjecture. The models allow for time varying volatility. Using 4 estimators based on mixtures of high, low, open and close prices, we found all estimators conclude that the volatility of the feeder cattle futures price decreased after switching from physical delivery to cash settlement. The change in the contract specification therefore enhances price discovery and risk management functions of the futures market. Concerning the higher moments of the volatility, different conclusions were derived. Range data, the Parkinson and the Rogers-Satchell estimators all indicate that cash settlement led to a reduction in the volatility of volatility.

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, Using High, Low, Open and Closing Prices to Estimate the Effects of Cash Settlement on Futures Prices. International Review of Financial Analysis, Forthcoming. Available at SSRN: https://ssrn.com/abstract=320804

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)

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