Effect of Stochastic Interest Rates on the Pricing of SPI Futures Contracts

The model most often used in empirically testing the pricing of share price index futures contracts is the no-arbitrage model. But this model is actually a forward, not a futures, pricing model. To apply the model to SPI futures, we must assume the equality of forward and futures prices. But the forward price and futures price need not be equal if interest rates are stochastic. This paper examines the appropriateness of assuming the equality of forward and futures prices. Cox, Ingersoll and Ross (1981) demonstrate that forward-futures price differential is given by the local covariance between the rate of return on the futures contract and the rate of return on a risk-free pure discount bond. The results presented in this paper question the appropriateness of assuming the equality of forward and futures prices, providing limited support for non-zero local covariance.