Optimal arbitrage strategies on stock index futures under position limits

Min Dai, Yifei Zhong, Yue Kuen Kwok

Research output: Journal article publicationJournal articleAcademic researchpeer-review

10 Citations (Scopus)

Abstract

Assuming the absence of market frictions, deterministic interest rates, and certainty in dividend payouts from the stocks in the index basket, an arbitrageur can lock in the profit of a positive (negative) arbitrage basis in a stock index futures by adopting a short (long) futures strategy. In addition, the arbitrageur may improve the arbitrage profit by adopting the so-called early unwinding strategy of liquidating the position before maturity, or more aggressively from the long position directly to the short position or vice versa. In this study, we examine the optimal arbitrage strategies in stock index futures with position limits and transaction costs. In our analysis, the index arbitrage basis is assumed to follow the Brownian Bridge process. The model formulation of the option value functions leads to a coupled system of variational inequalities. We determine the values of the arbitrage opportunities and the optimal threshold values of the arbitrage basis at which the arbitrageur should optimally close an existing position or open a new index arbitrage position. In particular, we examine the impact of transaction costs on the index arbitrage strategies.

Original languageEnglish
Pages (from-to)394-406
Number of pages13
JournalJournal of Futures Markets
Volume31
Issue number4
DOIs
Publication statusPublished - Apr 2011

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting(all)
  • Finance
  • Economics and Econometrics

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