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Price Leadership between Spot and Futures Markets
, Chaturvedula Chakrapani
Published in
2013
Volume: 3
   
Issue: 1
Pages: 93 - 107
Abstract
The introduction of derivatives segment from the early 2000s onwards has led both to interactions between the spot and futures markets and to an interest by regulators in controlling any possible harmful influences of this new trading segment. The Individual Stock Futures (ISF) segment is of phenomenal success on Indian bourses and NSE is consistently ranked number one in world ISF segment, even in the absence of strong stock lending mechanism. It is expected that the futures prices can reflect additional information, over and above that already reflected in the spot price, given the leverage benefits and so can serve as a leading indicator for the spot price. So far, no study looks at the ISF contribution to the spot segment and this study attempts to fill that gap. The traditional approach of analyzing the inter-linkages between spot and futures market concentrates on examining causality dynamics in returns and volatilities and do not address the 'extent' of price discovery either in spot or futures market. We follow the Information shares approach as suggested in Hasbrouck (1995, 2002) which takes into account the variability of the innovations in each market's price. We consider intra-day data (one-minute and five-minute) of 46 NSE Nifty constituent stocks spot and futures segment during Jan 2004 to March 2007. We find that the spot and futures prices are co integrated and mutually adjusting. Building on Information Share approach of Hasbrouck, the price discovery share of futures segment is about 36% compared to that of spot segment is 64%. It is expected that futures market contribute more towards price discovery given huge trading volumes and they carry the natural advantage of cost-effectiveness in terms of leverage benefit. However, the empirical result (or the fact) is spot market leadership in price discovery and this fact is reconciled by probing the clientele of futures market and is consistent with very active participation of retail traders in futures segment.
About the journal
JournalJournal of Applied Finance and Banking
Open AccessNo