Why Futures Prices Deviate from Fair Value as Expiry Approaches

Summary

The document explains that a futures contract’s fair value can itself move as market expectations change. For equity index futures, uncertainty about future dividends and the cost or benefit of borrowing the underlying can shift the estimated fair value, so observed futures prices may appear above or below a reference estimate. The response therefore cautions against interpreting every fluctuation around fair value as an independent market effect.

It also describes how the behavior can differ by underlying. As equity futures approach expiration, dividend and financing uncertainty generally has less time to affect fair value, so that value may become less volatile. In some commodity markets, storage and delivery conditions can make fair value more volatile near delivery. These are qualitative explanations rather than a pricing formula or measured empirical results; the document does not quantify deviations or establish a trading signal from them.

Key ideas

• Fair value can change as expectations about dividends and borrowing costs change.
• Futures prices may lie above or below an estimated fair value as these inputs shift.
• For equity futures, fair-value uncertainty may decline as expiration approaches.
• Commodity storage and delivery conditions can increase fair-value volatility near delivery.
• The discussion is qualitative and does not provide a quantitative pricing or trading method.

Tags

# Futures Fair value and its price


# Futures Fair value and its price












Lately I have been doing some research on some equity index futures. What seems interesting to me is that the futures price will fluctuate around the fair value of the futures. With little research or study on this topic as far as I am concerned, is there any implication of this phenomenon?

That is, what caused the futures price to fluctuate around the fair value? Why is it sometimes higher than the fair value and sometimes lower than the fair value?

## Answer by JoshK (score 2, accepted)

https://quant.stackexchange.com/a/58674

I think you are looking at it wrong. The fair value of futures fluctuates. There is constant uncertainty around both the dividend stream and the borrow premium (or discount). This moves around as the market sets its expectations.

For equities, as you get closer to expiration you will see the fair value become less and less volatile as there is much less uncertainty.

For some commodities, like oil, you will see the fair value become more volatile (sometimes) as small changes in the storage and delivery market move the fair value as we approach delivery.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.