Comparison of theoretical and market Future prices of Stock Indices and Stocks in India and developed markets abroad


Derivatives and Risk Management

at the end of which it is settled. Theoretical Future price should factor the current price and holding costs. NASDAQ and Tokyo Stock Exchange. r= zero coupon risk free rate of return.Project Objective: Develop a theoretical model for future prices of different underlying and compare it with the future prices in NSE. A difference in the theoretical prices and market prices is expected because of the assumptions in the model. Futures Price = Spot Price + Cost of Carry The Cost of carry is the sum of all costs incurred if a similar position is taken in cash market and carried to maturity of the futures contract less any revenue which may result in this period. There are other complex theoretical models available in literature which would be evaluated. These theoretical prices would be compared with the market future prices using the goodness of fit tests . Back Ground and Methodology: A Futures contract is specified for a period of time. T=time until delivery date. In order to compensate the seller for waiting till expiry for realizing the sale proceeds the buyer has to pay some interest which is reflected in the form of cost of carry. y = cash yield on underlying asset.The best possible theoretical model would be found. Theoretical Future prices can also be found using the formula F0=S0 *e^(rT) One more model which predicts the theoretical prices is as follows: F0= S0+ S0*(r-y) Where F0= Future Prices today. The basic assumptions in the theoretical models are: . S0= Spot Prices.

. Instead of buying or selling every asset in the index. which may lead to disparity in tracking the index. a portfolio of a smaller number of assets may be considered to track the index. The borrowing rate and lending rate are equal. Transaction costs are ignored. 2. The evaluation would be done using data for 2 years between Jan 2007 and Jan 2009.1. No interim cash flow due to variation in margins are assumed further any cash flow payments from the underlying assets are assumed to be paid at the delivery date rather than at an interim date. 4. 3. or an index. The underlying asset for some futures contract is not a single stock but a basket of assets.