Contract Design: A Note on Cash Settled Futures
This note presents an intuitive interpretation and expression for pricing cash settled futures contracts. In particular, the choice of the averaging period for the underlying cash index is evaluated. A question arises as to how the choice of the averaging period may effect how the futures contract is priced. In this note, it is shown that under certain assumptions, the behavior of the futures price prior to entering the expiration interval is independent of the averaging intervals length for storable commodities. However, this is not the case for nonstorable commodities. An examination of the Minneapolis Grain Exchanges National Corn Index futures provides empirical support for the results. Given the increasing interest in cash settled futures, especially for futures contracts on agricultural commodities, these results should prove useful to futures exchanges when considering contract design. Ultimately, contract design choices are a critical factor in the success of any futures contract. In the context of agricultural futures contracts, successful contracts can contribute to increased social welfare and greater efficiency of the food marketing system.
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Volume (Year): 1 (2003)
Issue (Month): 1 (February)
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