The Cost-Of-Carry Formula to Determine Futures Prices: How Wrong Can You Be?

In this note we analyze the pricing error of using the cost-of-carry formula to determine futures prices. When the underlying asset is a share of stock, the sign of the pricing error is basically determined by the sign of the correlation between the stock return and short-term risk-free interest rate. When the underlying asset is a zero-coupon bond, the forward price is an upper bound for the pricing error.