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Futures contract collateralization and its implications

Author

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  • Jarrow, Robert A.
  • Kwok, Simon S.

Abstract

Defining a futures return as the rate of change of futures prices, as done in many empirical studies, implicitly implies that a futures contract is fully collateralized. We adjust futures’ returns to explicitly account for the holding of minimum margin (collateral) and the return to this collateral. Collateralization adjustment affects the dynamic properties of returns and modifies the risk profile of futures contracts. In our empirical study, we document the effect of such adjustment under full and partial collateralization. The effect is minimal except when the futures prices and minimum margins are volatile. Our analysis calls for a review on the extent of diversification benefits offered by futures.

Suggested Citation

  • Jarrow, Robert A. & Kwok, Simon S., 2023. "Futures contract collateralization and its implications," Journal of Empirical Finance, Elsevier, vol. 74(C).
    • Handle: RePEc:eee:empfin:v:74:y:2023:i:c:s0927539823000890
    DOI: 10.1016/j.jempfin.2023.101422
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    More about this item

    Keywords

    Commodity futures; Futures return; Collateral; Leverage; Correlation;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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