When futures contracts on stock market indexes began trading in 1982, most people expected the futures price to be higher than the current level of the index by an amount equal to the interest rate on risk-free securities minus the dividend yield on the index portfolio. This would have been consistent with market equilibrium conditions. Instead, futures contracts were priced at a discount to the spot index itself.

There are several explanations for why futures may sell at a slight discount in an equilibrium market. Because a short seller must pay the dividends on borrowed shares, a short stock-long futures arbitrage becomes profitable only when the futures price is below the current spot index by an amount greater than the dividend yield on the index portfolio. Also, a stock portfolio offers certain tax advantages a futures position lacks. If its value declines, the investor can sell a stock portfolio and deduct the loss at short-term rates; if value increases, he can hold on and take advantage of long-term capital gains rates. Stock index futures may be priced below their theoretical level by an amount equal to this “timing option.”

Even taken together, however, these arguments appear insufficient to explain the magnitude of the discount observed in early stock index futures markets. It is more likely that the discount represented a situation of disequilibrium—a transitory phenomenon caused by unfamiliarity with the new markets and institutional inertia in developing systems to take advantage of the opportunities presented.