A Comparison of Hemler & Longstaff Model and Cost of Carry Model: The Case of Stock Index Futures

Abstract

The study empirically tests and compares the pricing performance of two alternative futures pricing models ; the standard Cost of Carry Model and Hemler & Longstaff Model (1991) for three futures indices of National Stock Exchange (NSE), India – CNX Nifty futures, Bank Nifty futures and CNX IT futures. It is found that, Hemler & Longstaff Model in a continuous economy with stochastic interest rate and Market volatility provides better pricing performance than standard Cost of Carry Model for CNX Nifty futures and  Bank Nifty Futures market. The regression results of CNX Nifty and Bank nifty futures are consistent with the empirical implications of the Hemler & Longstaff‘s equilibrium model and supports Market Volatility related to stock index futures prices. The regression results of CNX IT Futures support the Cost of Carry model and provides better pricing performance than Hemler & Longstaff Model. On the basis of pricing performance, in terms of  Mean Absolute Pricing Error( MAPE) , the preferred contract is CNX Nifty futures contract, followed by Bank Nifty futures and CNX IT futures contract for both the  pricing models.