Exchange Traded Contracts for Difference : Design, Pricing and Effects

Contracts for Difference (CFDs) represent a significant financial innovation in the design of futures contract. Their use in over-the-counter markets has grown significantly and has created controversy in the UK, but to date there have been no published academic studies examining CFD markets. In 2007, the Australian Securities Exchange (ASX) introduced exchange-traded CFDs on individual stocks and other financial instruments. This paper analyzes the contract design and consequences for pricing relationships between CFDs and the underlying stocks. Using the unique database of ASX CFD trades and quotes, we test empirically whether the pricing relationship conforms to theoretical expectations, how spreads in the derivative market are related to those in the physical market, and draw out implications for successful design and trading arrangements for the introduction of new derivative contracts