General equilibrium pricing of nonredundant forward contracts

We derive the general equilibrium of a dynamic financial market in which the investors' opportunity set includes nonredundant forward contracts. We show that Breeden's (1979) consumption-based CAPM equation for forward contracts contains an extra term relative to that for cash assets. We name this term a strategy risk premium. It compensates investors for the (systematic) risk that stems from their very portfolio strategies when the latter involve nonredundant forward contracts. We also show that Merton's (1973) multibeta intertemporal CAPM must be amended for forward contracts to exhibit adjusted risk premia for the market portfolio and all relevant state variables, as opposed to the usual risk premia for cash assets. Our results are shown not to depend on the usual cash-and-carry relationship, which, in general, does not hold. We, nevertheless, provide a well-known special case where it does hold, albeit not grounded on the usual no-arbitrage argument. (C) 2003 Wiley Periodicals, Inc.