An Alternative Formulation for the Pricing of Stock Index Futures: Theoretical and Empirical Perspectives
AbstractAssuming that a futures price is a function of the underlying asset and the basis, and that a Brownian bridge process drives the basis, this article provides the closed-form solution of futures with basis risk (FBR). The Brownian bridge process ensures that the basis is zero at the maturity of a futures contract. The FBR model is empirically tested with daily S&P500 futures data and is found to outperform both the Cornell and French (CF, 1983a) and Yan (2002) models. The overall mean errors in terms of index points and percentages are 0.1918 and -0.002% for the FBR model, compared to -1.8806 and -0.2088% for the CF model, and 2.5072 and 0.0973% for the Yan model.
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Bibliographic InfoArticle provided by College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan in its journal International Journal of Business and Economics.
Volume (Year): 6 (2007)
Issue (Month): 2 (August)
futures; basis risk; Brownian bridge;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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- Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm54, Yale School of Management.
- Hemler, Michael L. & Longstaff, Francis A., 1991. "General Equilibrium Stock Index Futures Prices: Theory and Empirical Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(03), pages 287-308, September.
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- Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
- Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm65, Yale School of Management.
- Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997. " Empirical Performance of Alternative Option Pricing Models," Journal of Finance, American Finance Association, vol. 52(5), pages 2003-49, December.
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