Which Dividends Matter When Pricing an Equity Forward
Summary
The document asks whether dividends paid after an equity forward expires should affect its price, using a forward expiring partway through a month as an example. The response explains the price through a cash-and-carry replication: an investor borrows to buy the stock, holds it until delivery, and pays funding costs. Dividends received during that holding period can be reinvested and reduce the effective cost of financing the position.
On that replication logic, only dividends falling within the period from initiation through forward maturity contribute to the forward price. A dividend after delivery is outside the replication period and is not included, even if it accrues economically before its payment date. The answer notes a practical complication: the ex-dividend date and the payment date may differ. It gives a conceptual explanation rather than a numerical formula or treatment of taxes, discrete market frictions, or uncertain dividends.
Key ideas
- A long equity forward can be understood through borrowing cash to buy and carry the stock until delivery.
- Dividends received during the replication period can be reinvested and reduce effective funding cost.
- Only dividends falling between forward initiation and maturity affect its price under this replication argument.
- A dividend paid after maturity is outside the holding period used to replicate the forward.
- Ex-dividend dates and payment dates can differ and complicate practical pricing.
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Full text
# Role of next month's dividends in forward pricing # Role of next month's dividends in forward pricing I'm using the equations given on this page to price forwards on an equity. It's a basic equation that discounts dividends. But my question is: What do we do about dividends that occur after the forward's expiration date? For example, consider a stock that pays dividends on the last day of every month in the year. Say I want to price the forward that expires on the 15th of March. According to that webpage, I only need to discount dividends paid on January 1st, February 1st, and March 1st. But what about the dividend that will be paid on April 1st. On March 15th, we would be halfway through the month and the stock will have accrued half of the value of the next dividend. So how should I treat months after the forward? Thanks. ## Answer by Quantuple (score 3, accepted) https://quant.stackexchange.com/a/36668 A long equity forward position initiated at $t=0$ for delivery at $T$ can be replicated by borrowing cash to purchase the stock at $t=0$, carrying that stock up to $T$ and paying the interests on the cash borrowed (cash & carry). This shows that the forward price is basically the cost of funding the equity purchase. Now if the stock pays dividends the proceeds can be reinvested, which contributes to decreasing the effective funding cost. Obviously only the dividends falling over the replication period $]0,T]$ can be reinvested and hence matter in pricing the forward $F(0,T)$. In practice there is an additional complication due to the 'ex-dividend' date versus 'payment' date discrepancy but the idea remains the same.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.