Short-selling restrictions, strategic stock holdings and index futures markets in Finland

Abstract

The goal of the paper is to rationalize the observed persistent underpricing in the Finnish stock index futures market.It is shown that under a binding short-selling restriction on stocks the observed futures "underpricing" can be a result of strategic motives of the Finnish industrial and financial groups to hold large amounts of stocks, which implies a net futures demand for hedging part of the financial risk brought in by these strategic holdings."Underpricing" can also emerge under short-selling restrictions, if strategic investors are better informed than other traders.Two main empirical implications of the model - a negative relationship between the futures basis and stock index volatility and a positive relationship between the basis and private information signals received by informed investors - are supported by the Finnish data from May 1988 to December 1990.