ABSTRACT

Numerous studies have been carried out on the pricing of stock index futures based on cost of carry model. However, the findings are controversial. In this study, the pricing of KLSE CI futures is examined under both the cost of carry model and the imperfect market model developed by Hsu and Wang (1998). In particularly, this study is structured to serve the following purposes:
(a) To test the adequacy of the cost of carry model in the context of KLSE CI futures market;
(b) To compare the predictive powers of the two models; and
(c) To examine the impacts of stock market volatility and other important factors including instantaneous growth rate, time to maturity and risk free interest rate on the logarithm of futures/spot price ratio.

Using the data from January 2, 1996 to March 31, 2002, the results are summarized as below:

(a) With cost of carry model, the KLSE CI futures produce significant and persistent arbitrage opportunities.
(b) Price expectation plays a significant role in pricing of the KLSE CI futures.
(c) The model that best explained the actual KLSE CI futures market is differed from cost of carry model in mathematical form and carrying cost amount.
(d) The cost of carry model has the lowest predictive power as compared to imperfect market model in formulating estimate on the KLSE CI futures prices. Among the three different imperfect market models discussed in this study, the model that uses the implied method in estimating the instantaneous growth rate has the highest predictive power. This is followed by that uses the adaptive expectations method of 2 lags and then 1 lag.
(e) The instantaneous growth rate, time to maturity and risk free interest rate have significant impacts on the logarithm of futures/spot ratio, while the impact of stock market volatility is insignificant. However, the impact of the instantaneous growth rate is more significant than the risk free interest rate.

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