he prices observed for stock index futures have surprised both academics and T practitioners. The price structure, which gives the relation between the futures and spot prices as a function of the time to maturity, is generally flatter than simple arbitrage models predict. In fact, the futures prices are often below the spot price. This has led some practitioners to conclude that arbitrage profits could be earned by selling stock and buying futures contracts. In this article we suggest that the relatively low futures prices reflect the impact of taxes, not market inefficiency.
Throughout the article we assume that forward and futures prices are equal. Of course, it is now well known that these prices will not be exactly equal if interest rates are stochastic because futures contracts are settled daily and forward contracts are not settled until the contract matures. Cox, Ingersoll, and Ross (1981), Jarrow and Oldfield (198lX Richard and Sundaresan (198lX and French (1982a) examine the theoretical difference between forward and futures prices in a variety of contexts. Nonetheless, simulations and empirical studies by Rendleman and Carabini (19791, Cornell andReinganum (1981), andElton, Gruber, andRentzler (1982) indicate that the difference is economically insignificant.' In the remainder of this article forward and futures prices are used interchangeably.
The empirical results presented here are limited to contracts on the S & P 500 index and the New York Stock Exchange composite index. The Value Line index is excluded because it is not a value-weighted average. Instead, it is based on a geometric average of the component stocks' price changes. This means that the rate of change in the Value Line index is not equal to the return one would receive from holding the component stocks. Rather than complicate the results of our study by attempting to adjust for the bias produced by the geometric averaging, we ignore the Value Line contract.
'French (198%) finds a statistically aignifiant difference between futures and fomard p r i a for copper and silver. However, since he finds that the futures prices are generally larger than the forward p h , distinguishing between these prices would magnify the puzzle, rather than explain i t