A Note on Forward Price and Forward Measure

Byline: Ren-Raw Chen (1), Jing-Zhi Huang (2) Keywords: forward measure; forward price; stochastic interest rates Abstract: The forward measure is convenient in calculating various contingent claim prices under stochastic interest rates. We demonstrate that caution needs to be drawn when the forward measure is used to price contingent claims that involve multiple cash flows. We also derive partial different equations for the forward price to demonstrate how forward contracts can be used for dynamic hedging and how hedges can be conducted if the payoff of a contingent claim depends on the forward price. Author Affiliation: (1) FOM/SOB-NB, Rutgers University, Levin Bldg., Rockafeller Rd., Piscataway, NJ, 08854 (2) Smeal College of Business, Penn State University, University Park, PA, 16802 Article History: Registration Date: 13/10/2004