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Lately I have been doing some research on some equity index futures. What seems interesting to me is that the futures price will fluctuate around the fair value of the futures. With little research or study on this topic as far as I am concerned, is there any implication of this phenomenon?

That is, what caused the futures price to fluctuate around the fair value? Why is it sometimes higher than the fair value and sometimes lower than the fair value?

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I think you are looking at it wrong. The fair value of futures fluctuates. There is constant uncertainty around both the dividend stream and the borrow premium (or discount). This moves around as the market sets its expectations.

For equities, as you get closer to expiration you will see the fair value become less and less volatile as there is much less uncertainty.

For some commodities, like oil, you will see the fair value become more volatile (sometimes) as small changes in the storage and delivery market move the fair value as we approach delivery.

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  • $\begingroup$ I have to add this answer that supply and demand is a fundamental factor. Even when a security's price is directly defined by a collection of certain asset prices the liquidity and market positioning of the instruments can drive a fundamental basis in the prices (that represents theoretical arbitrate, but not practically transactable arbitrage) $\endgroup$ – Attack68 Oct 14 '20 at 13:24
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    $\begingroup$ Agreed - it's important to understand that models will use the carry rate as "risk-free + borrow". But these are not objective, scientific things. The market will often have lots of uncertainty around them and they will fluctuate with supply and demand. $\endgroup$ – JoshK Oct 14 '20 at 13:41

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