n two articles, French (1983a, 1983b) argue that the prices of stock I index futures contracts may be less than predicted by a model which assumes perfect markets and ignores taxes, because futures traders lose the tax timing option. This article presents empirical tests of that conjecture. The results reveal that the timing option is not an important factor in pricing stock index futures. Though large discrepancies between the theoretical price derived from a perfect-markets model and actual futures prices are occasionally observed, the pattern of the discrepancies is not consistent with the predictions of the timing option model. Two explanations are offered for thk finding. First, the timing option may be worthless because the marginal investor is a tax-exempt institution. Even if floor traders and arbitrageurs are the marginal investors, the timing option may still be of limited value because such active traders do not hold the cash security indefinitely and thus forego the timing option. Secondly, it is possible that transaction costs, limitations on capital loss deductions, and other tax-related constraints reduce the value of the timing option.
The organization of the article is as follows. The next section briefly reviews the perfect markets model and the timing option theory. The empirical results are presented in section three along with a discussion of their implications. The article concludes with a brief summary.
I. THE TIMING OPTION AND THE PRICING OF STOCK INDEX FUTURES
Throughout this article I ignore the effect of daily settlement on futures prices.
Though daily settlement can theoretically affect futures prices, simulations and empirical studies by , Cornell and Reinganum *The author would like to thank two anonymous referees of this journal for their helpful comments. An earlier version of this article was presented at the Berkeley Program in Finance.