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Contract Design: A Note on Cash Settled Futures

Author

Listed:
  • Manfredo Mark R

    (Arizona State University, Tempe, Arizona, USA)

  • Sanders Dwight R

    (Southern Illinois University, Carbondale, Illinois, USA)

Abstract

This note presents an intuitive interpretation and expression for pricing cash settled futures contracts. In particular, the choice of the averaging period for the underlying cash index is evaluated. A question arises as to how the choice of the averaging period may effect how the futures contract is priced. In this note, it is shown that under certain assumptions, the behavior of the futures price prior to entering the expiration interval is independent of the averaging interval's length for storable commodities. However, this is not the case for nonstorable commodities. An examination of the Minneapolis Grain Exchange's National Corn Index futures provides empirical support for the results. Given the increasing interest in cash settled futures, especially for futures contracts on agricultural commodities, these results should prove useful to futures exchanges when considering contract design. Ultimately, contract design choices are a critical factor in the success of any futures contract. In the context of agricultural futures contracts, successful contracts can contribute to increased social welfare and greater efficiency of the food marketing system.

Suggested Citation

  • Manfredo Mark R & Sanders Dwight R, 2003. "Contract Design: A Note on Cash Settled Futures," Journal of Agricultural & Food Industrial Organization, De Gruyter, vol. 1(1), pages 1-14, February.
    • Handle: RePEc:bpj:bjafio:v:1:y:2003:i:1:n:8
    DOI: 10.2202/1542-0485.1005
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    References listed on IDEAS

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    1. Josué Martínez‐Garmendia & James L. Anderson, 1999. "Hedging performance of shrimp futures contracts with multiple deliverable grades," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 19(8), pages 957-990, December.
    2. Tashjian, Elizabeth, 1995. "Optimal futures contract design," The Quarterly Review of Economics and Finance, Elsevier, vol. 35(2), pages 153-162.
    3. Sarahelen Thompson & Philip Garcia & Lynne Dallafior Wildman, 1996. "The demise of the high fructose corn syrup futures contract: A case study," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 16(6), pages 697-724, September.
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