Modeling Futures Contracts
Most of the modeling principles we learned in the last chapter are applicable to the subject of this chapter: futures contracts (aka futures). Futures share many features with forward contracts, but a fundamental difference between them is how each one approaches the risk factor. Forward contracts are risky, with the shadow of a default always looming. Futures contracts, on the other hand, are deemed to be less risky because they are traded on exchanges. Exchange-imposed rules buffer investors against some of the risk because they make default events less likely. Every major exchange has implemented a set of intricate rules that all concerned parties must follow and obey. Moreover, each exchange’s enforcement of these rules guarantees that a contract has a good chance of being honored by each contract participant.