Pricing of single stock futures and dividend risk

ABSTRACT

In this paper we consider the fair pricing of single stock futures (SSFs) and the effect of dividend risk on the dividend compensation component in the pricing formulas. SSF valuation is subject to the pricing of discrete cash dividends (not percentages or dividend yields) in the underlying stock. Discrete cash dividends present modelling challenges which are not present when dividends are in the form of yields or percentages. Problems are created for market-makers and investors when the actual cash dividend is different from that predicted by analysts and used for pricing. We propose a new model for the fair price of a single stock futures contract which addresses dividend uncertainty.