What Explains the Difference between the Futures' Price and its 'Fair' Value? Evidence from the European Options Exchange

Posted: 25 Aug 1998

See all articles by Tom Berglund

Tom Berglund

Hanken School of Economics - Department of Economics

Rezaul Kabir

University of Twente - Department of Finance and Accounting

Abstract

This paper analyzes systematic deviations of the observed futures price from the value predicted by the simple cost-of-carry relationship. A model to explain this deviation (the basis) is presented in Chen, Cuny, and Haugen (1995, henceforth CCH). According to CCH, the basis should be negatively related to the return volatility of the underlying instrument. CCH themselves find support for their model on data for S&P 500 contracts in the USA. However, since the data used by CCH in testing their model at least to some extent was familiar to them when developing the model, there is a need for a test on data that is completely independent of their data. The purpose of our study is to report the results of such a test. The data is for stock index futures on the European Options Exchange in Amsterdam. The period covered is 1991 through 1993. Our results are consistent with the predictions of the CCH model. An increase in perceived volatility of the underlying index will cause a drop in the basis, as well as an increase in the open interest on the futures market.

JEL Classification: G12, G13

Suggested Citation

Berglund, Tom Patrik and Kabir, Rezaul, What Explains the Difference between the Futures' Price and its 'Fair' Value? Evidence from the European Options Exchange. Available at SSRN: https://ssrn.com/abstract=6587

Tom Patrik Berglund

Hanken School of Economics - Department of Economics ( email )

PO Box 479
FI-00101 Helsinki
Finland
+358-9-43133 345 (Phone)
+358-9-43133 382 (Fax)

Rezaul Kabir (Contact Author)

University of Twente - Department of Finance and Accounting ( email )

Faculty of Behavioral, Management & Social Science
P. O. Box 217
Enschede, 7500 AE
Netherlands
+31 53 489 4512 (Phone)
+31 53 489 2159 (Fax)

HOME PAGE: http://https://people.utwente.nl/r.kabir

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