The IUP Journal of Applied Economics
Price Discovery Behavior of Spot and Futures: Evidence from Pre- and Post-Crisis Periods

Article Details
Pub. Date : Oct, 2019
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE21910
Author Name : VDMV Lakshmi and Medha Joshi
Availability : YES
Subject/Domain : Economics
Download Format : PDF Format
No. of Pages : 19

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Abstract

The study attempts to examine if there is any shift in the price discovery behavior of spot and futures markets between pre-crisis period and post-crisis period. All those stocks which are available for trading in futures segment since the launch of futures trading on November 9, 2001 to December 31, 2018 have been considered for the purpose of the study so as to understand the behavior of the stocks in price discovery process in pre-crisis, crisis and post-crisis periods. To measure the price discovery effects, the study uses Johansen’s cointegration and Vector Error Correction Model (VECM), as it helps in investigating which market (spot or futures) leads in discounting the potential value of the information. The study also applies Hasbrouck’s information share approach to investigate the proportion of contribution of each market to price discovery. The results indicate that there is evidence of futures market leading spot market during pre-crisis period. However, the leading role of futures disappeared during the crisis period. It may be attributed to the fear of market participants to trade in high levered instruments. Rather, there is evidence of leading of spot market during the crisis period and also after the crisis period. On the whole, it is observed that spot market plays a dominant role in price discovery as against the general premise that futures being low-cost instruments lead in price discovery. This phenomenon may be attributed to relatively low participation of informed institutional investors in Indian futures segment.


Description

India’s major stock exchanges, National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), launched futures trading in individual stocks in November 2001. The purpose of Securities and Exchange Board of India (SEBI) in introducing future trading is to bring informational efficiency through price discovery mechanism. When a stock is available for trading in both spot market and futures market, market participants are expected to approach futures market to reflect their viewpoint due to its advantages of low cost and high leverage.

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