Abstract
The delivery terms of futures contracts specify the types and grades of deliverable goods, and denote the places and times of delivery that must be met to avoid default on an outstanding contract. It is exceedingly difficult to ascertain proper specifications for a futures contract. But if the contractual terms are improperly specified, too few buyers or too few sellers of the contract will appear in the market at any given price, and the contract will fail.
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References
Chicago Board of Trade, p. 31.
Federal Trade Commission, v. V, p. 199.
See Telser (1981b); Carlton.
Pirrong (1991) demonstrates that the effects of supply, demand, and transportation conditions on basis risk are extraordinarily complex and not necessarily stable. A variety of changes in these conditions either singularly or in combination can lead to a decline in the size of a market similar to that experienced by Chicago. The analysis in the 1991 paper demonstrates that in many cases the effect of such an evolution in trading patterns on basis volatility for out-of-position hedgers often cannot be signed a priori even if a single change (e.g., a rise in demand at a single point) is responsible for this shift. When there are multiple causes of such a decline, it is often more difficult to determine whether the decline in a market is associated with a fall or a rise in the hedging performance out-of-position hedgers receive. This hedging performance may vary over time, moreover, due to changes in factors that do not affect market size per se, such as the volatility of demand at a particular location or the volatility of transport rates. Thus one cannot draw the conclusion that the decline in the Chicago market has increased the magnitude of basis risk.
See Milgrom (1981) for a classic exposition of this idea.
There may be dispersion in prices even if transactions costs are zero (see Telser (1978) ch. 8), but the permissible prices would still satisfy the constraint. When search costs are positive, some prices will exceed and some prices will be less than an efficient price.
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© 1993 Springer Science+Business Media New York
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Pirrong, S.C. et al. (1993). The Role of the Futures Delivery Process. In: Grain Futures Contracts: An Economic Appraisal. Springer, Boston, MA. https://doi.org/10.1007/978-1-4615-3238-5_2
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DOI: https://doi.org/10.1007/978-1-4615-3238-5_2
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