Abstract
This study explores the arbitrage opportunities in Deliverable Future Contracts (DFC) due to mispricing and the factors affecting it. We use the cost of carry model to calculate the fair prices of futures. We use mispricing as a direct measure of arbitrage opportunities. With one-year daily data collected from the data portal of Pakistan Stock Exchange, we calculate mispricing for twenty-two stock futures. Summary statistics of mispricing confirm the presence of arbitrage opportunities in this market. We also examine the relationship of mispricing with the time to contract expiry, stock return volatility, the trading volume of ready and future market, and open interest. Tobit regression results indicate that apart from open interest, all other factors possess significant explanatory power for mispricing.
Highlights
A large number of studies have been devoted to check the pricing efficiency of futures, being traded on various stock markets worldwide
The main objective of this study is to examine arbitrage opportunities in Deliverable Futures Contracts (DFC) at Pakistan Stock Exchange (PSX) with respect to time to maturity, price volatility of the underlying stock, the liquidity of cash and futures market, and open interest
Single stock futures are being traded in Pakistan since the year 2001
Summary
A large number of studies have been devoted to check the pricing efficiency of futures, being traded on various stock markets worldwide. These studies have used the famous cost of carry model, developed by Cornell and French (1983), to arrive at fair prices of futures contracts. Any difference of fair price of futures contract from its actual price i.e. mispricing, is an arbitrage opportunity. Earlier studies examined the mispricing in relation to some factors. These factors mainly include time to contract expiry, volatility of underlying stock, liquidity, and open interest, etc. Many researchers confirmed the existence of arbitrage opportunities in derivatives and the significant effect of the aforesaid factors
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