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 documented and alternative explanations are examined. No‐arbitrage pricing bands are computed using alternative sets of transaction costs and short sale restrictions faced by different investor groups. We find that a substantial portion of the mispricing can be explained by these factors, though a high incidence of mispricing remains after accounting for costs faced by the marginal trader group—the KSE exchange members. We also observe frequent underpricing of futures during periods of downward market trends. This is attributed in part because of unique restrictions on short sales and accounting conventions in the Korean market. In addition, tests of alternative futures pricing models are conducted that provide mixed results. Though we do not reject 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. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 153–174, 1999