Optimal contract design: For whom?

Nicolas P.B. Bollen, Tom Smith, Robert E. Whaley*

*Corresponding author for this work

    Research output: Contribution to journalReview articlepeer-review

    32 Citations (Scopus)

    Abstract

    In designing a derivative contract, an exchange carefully considers how its attributes affect the expected profits of its members. On November 3, 1997, the Chicago Mercantile Exchange doubled its tick size of its S&P 500 futures contract and halved the denomination, providing a rare opportunity to examine empirically the search for an optimal contract design. This article measures changes in the trading environment that occurred in the days surrounding the contract redesign. We find a discernible change in the incidence of price clustering, an increase in the bid/ask spread, a reduction in trading volume, and no meaningful change in dollar trade size. These results suggest that the contract redesign did not increase accessibility but did increase market maker revenue. Despite the increase, however, the bid/ ask spread of the S&P 500 futures contract remains low relative to the costs of market making and the spreads in markets for competing instruments.

    Original languageEnglish
    Pages (from-to)719-750
    Number of pages32
    JournalJournal of Futures Markets
    Volume23
    Issue number8
    DOIs
    Publication statusPublished - 1 Aug 2003

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