Optimal contract design: For whom?

✍ Scribed by Nicolas P. B. Bollen; Tom Smith; Robert E. Whaley

• Publisher: John Wiley and Sons
• Year: 2003
• Tongue: English
• Weight: 325 KB
• Volume: 23
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.10086

✦ Synopsis

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. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:719–750, 2003