A further look at transaction costs, short sale restrictions, and futures market efficiency: The case of Korean stock index futures

Persistent underpricing in the Korean stock index futures market is documen ted and alternative explanations are examined. No-arbitrage pricing bands a re computed using alternative sets of transaction costs and short sale rest rictions faced by different investor groups. We find that a substantial por tion of the mispricing can be explained by these factors, though a high inc idence of mispricing remains after accounting for costs faced by the margin al trader group-the KSE exchange members. We also observe frequent underpri cing of futures during periods of downward market trends. This is attribute d in part because of unique restrictions on short sales and accounting conv entions in the Korean market. In addition, tests of alternative futures pri cing models are conducted that provide mixed results. Though we do not reje ct:the standard cost-of-carry model, an equilibrium pricing model provides reasonable explanatory power. Further, use of the cost-of-carry model does not appear to be driving the findings of persistent underpricing. (C) 1999 John Wiley & Sons, Inc.