This study examines the price discovery and causality between stock index and its future in India. It investigates price discovery and the causal nexus between S&P CNX Nifty and Nifty futures for near-month, mid-month and far-month contracts separately. The objectives of the study are investigated by employing Johansen's cointegration test and the Vector Error Correction Model (VECM). The daily closing data is taken from June 12, 2000 to February 24, 2005 for near-month, mid-month and far-month contracts separately. All the required information for the study has been retrieved from the National Stock Exchange (NSE) website. The analysis reveals that spot leads futures, and the spot market transfers the information to the futures market.

Futures contract is an agreement to buy and sell an asset at a future time for a certain price which is traded in an organized exchange and the contract’s terms are standardized by organized exchange. The institutional environment includes a clearing house to guarantee to all trades and margin system design to protect the financial integrity of the market place. This system allows the futures market two social benefits: Price discovery, and risk transferring through hedging. Price discovery reveals how fast one market reflects new information relative to the other, and how well the two markets are linked. Risk management illustrates how the price risk of a certain position in the cash market may be reduced through futures market by hedgers. The dual roles of price discovery and risk transfer provide benefits that cannot be offered in the cash market alone and are often presented as justification of futures trading (Garbade and Silber, 1983).

The futures markets serve an important function of price discovery. Let us examine the concept of current cash price and expected cash price which will be helpful to identify the theoretical discomfiture pertaining to cash market and its future.

Assets are commonly traded in cash markets by a network of dealers, in which each dealer gives his own prices. This price often differs from one another either because dealers operate indifferent geographical markets or customers are
not aware of price differences that exist. To get the lowest price, a buyer needs a conduct time consuming and costly search in the market. Futures market provides highly visible prices against which the current cash prices of dealers can be compared. If prices of futures contract for immediate or near term delivery differ from dealer’s cash prices, traders can arbitrage this difference.

Applied Finance Journal, Empirical Analysis, Stock Index, Vector Error Correction Model, VECM, National Stock Exchange, NSE, Risk Management, Futures Trading, Financial Integrity, Futures Markets, Geographical Markets, Autoregressive Integrated Moving Average Technique, Stock Index Futures, Error Correction Model, Financial Derivatives Market.