maryli

I agree that the short benefits from an increase in dividends, since they are holding the stock in an arbitrage-free situation.

If we have a forward price "X", maturing at time "t", the long could invest X / e^rt to have X dollars at time t.

The short could purchase the stock at price "S", and then hold it to time t to deliver the stock. These transactions must be equivalent to avoid arbitrage, so the forward price can be calculated as follows, where d is the continuous dividend yield:

X / e ^ rt = Se^(-dt), ==>

X = Se^(-dt+rt)

Now say that the dividend yield "d" is higher than originally expected. This would cause the arbitrage-free forward price "X" to be lower. So the short gains and the long loses.



Edited 1 time(s). Last edit at Friday, May 13, 2011 at 01:21PM by Binky123.