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Price leadership between spot and futures markets

This paper aims to study the relative information shares of spot and futures market at the individual stock level to measure the price discovery in spot and futures market in the Indian capital markets. 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. | Journal of Applied Finance Banking vol. 3 no. 1 2013 93-107 ISSN 1792-6580 print version 1792-6599 online Scienpress Ltd 2013 Price Leadership between Spot and Futures Markets Kiran Kumar1 and Chakrapani Chaturvedula2 Abstract This paper aims to study the relative information shares of spot and futures market at the individual stock level to measure the price discovery in spot and futures market in the Indian capital markets. 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. JEL classification numbers G130 G140 Keywords Price Discovery Information Shares Stock Futures 1 Introduction Understanding the influence of one market on the other and role of each market segment in price discovery is the central question in market microstructure design and of utmost importance to regulators and academia. Price discovery is an important function of the exchange and it hints at where do informed traders trade. More precisely following Schreiber and Schwartz 1986 Price discovery is the process by which markets attempt to find their fair prices. If the markets are efficient and frictionless then price discovery should be instantaneous and contemporaneous. In practice between spot and derivatives segments or across different trading venues of the same stock price discovery takes place in one market and the other markets follow it. The market leader is the one which 1 .