CHAPTER 10Securities Futures Products Refinements.ppt

Chapter 10 CHAPTER 10Securities Futures Products Refinements In this chapter, we extend the discussion of stock index futures. This chapter is organized into the following sections: Stock Index Futures Prices Program Trading Hedging with Stock Index Futures Asset Allocation Portfolio Insurance Index Futures and Stock Volatility Index Futures and Stock Market Crashes Stick Index Futures Prices In this section, the following issues are explored: The empirical evidence on stock index futures efficiency. do stock index futures prices conform to the Cost-of-Carry Model? The effect of taxes on stock index futures prices. The timing relationship between stock index futures prices and the cash market index. Does the futures price lead the cash market index, or does the cash market index lead the futures? The seasonal impacts on stock index futures pricing. Stock Index Futures Efficiency Recall that the success of an arbitrage opportunity can be affected by: The use of short sale proceeds Transaction costs Dividend variability Every real market has a range of permissible no-arbitrage prices. This no-arbitrage band increases because of transaction costs and restrictions on short selling. Evidence suggests that the futures market was inefficient in the early days of trading but now it conforms well to the Cost-of-Carry Model. Figure 10.1 shows the result of a study by Modest and Sundaresan. Stock Index Futures Efficiency Notice how the observed price is almost always within the no arbitrage bounds and never deviates far from them. Effect of Taxes on Stock Index Futures Prices Because futures prices are marked-to-market at year end for tax purposes, index futures contracts possess no tax-timing options. In the futures markets, tax rules require all paper gains or losses to be recognized as cash gains or losses each year. In the cash market, an individual can time his tax gains or losses. In an empirical study of the effect of the tax-timing option, Corne