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An Alternative Formulation for the Pricing of Stock Index Futures: Theoretical and Empirical Perspectives

Author

Listed:
  • Chou-Wen Wang

    (Department of Risk Management & Insurance, National Kaohsiung First University of Science & Technology, Taiwan)

  • Ting-Yi Wu

    (National Kaohsiung First University of Science & Technology, Taiwan and Department of Business Administration, Kao Yuan University, Taiwan)

Abstract

Assuming 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.

Suggested Citation

  • Chou-Wen Wang & Ting-Yi Wu, 2007. "An Alternative Formulation for the Pricing of Stock Index Futures: Theoretical and Empirical Perspectives," International Journal of Business and Economics, School of Management Development, Feng Chia University, Taichung, Taiwan, vol. 6(2), pages 121-134, August.
    • Handle: RePEc:ijb:journl:v:6:y:2007:i:2:p:121-134
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    References listed on IDEAS

    as
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    4. 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 923-973, July.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    futures; basis risk; Brownian bridge;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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