How electronic trading affects bid‐ask spreads and arbitrage efficiency between index futures and options

This paper examines the impact of switching to electronic trading on the relative pricing efficiency of Hang Sang Index futures and options contracts traded on the Hong Kong exchange. The study is motivated by the recent shift in 2000 from the pit to an electronic trading platform. Electronic trading leads to lower bid‐ask spreads and less price clustering than floor trading in both the options and futures markets. Mispricing between futures and options drops significantly after the change. Quicker correction of mispricing indicates a significant improvement in dynamic inter‐market arbitrage efficiency with electronic trading. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:375–398, 2005     

Pricing dynamics of index options and index futures in Hong Kong before and during the Asian financial crisis

This article studies the impact of the Asian financial crisis on index options and index futures markets in Hong Kong. We employed a time‐stamped transaction data set of the Hang Seng Index options and futures contracts that were traded on the Hong Kong Futures Exchange. The results show that during the crisis period, the arbitrage profits, and the standard deviations of these profits increased in both ex‐post and ex‐ante analyses. In a market turbulent time, market volatility brings a higher arbitrage profit level. However, despite the increased market volatility, the profitability of the arbitrage trades declined substantially with longer execution time lags in the ex‐ante analysis. This suggests that the HSI futures and options markets are mature and resilient. A multiple regression analysis on the ex‐post arbitrage profit also suggests that there were structural changes during the Asian financial crisis and the Hong Kong government intervention periods. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20: 145–166, 2000     

THE EFFECT OF TRADING FUTURES ON SHORT SALE CONSTRAINTS

It is commonly believed that the trading of futures on a commodity enables the market to overcome short selling constraints on the spot commodity itself. This belief is embedded in the notion that trading strategies involving futures contracts enable traders to replicate the payoffs as if they were short the spot commodity. The purpose of this paper is to investigate this common belief in a general arbitrage‐free semimartingale financial model with trading in futures and a short selling prohibition on the spot commodity. We show via various examples that, in general, this common belief is incorrect. Furthermore, we provide a set of sufficient conditions, albeit very restrictive, under which the common belief is true.     

A further look at transaction costs,short sale restrictions,and futures market efficiency: The case of Korean stock index futures

Persistent underpricing in the Korean stock index futures market is documented and alternative explanations are examined. No-arbitrage pricing bands are computed using alternative sets of transaction costs and short sale restrictions faced by different investor groups. We find that a substantial portion of the mispricing can be explained by these factors, though a high incidence of mispricing remains after accounting for costs faced by the marginal trader group—the KSE exchange members. We also observe frequent underpricing of futures during periods of downward market trends. This is attributed in part because of unique restrictions on short sales and accounting conventions in the Korean market. In addition, tests of alternative futures pricing models are conducted that provide mixed results. Though we do not reject the standard cost-of-carry model, an equilibrium pricing model provides reasonable explanatory power. Further, use of the cost-of-carry model does not appear to be driving the findings of persistent underpricing. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 153–174, 1999     

The impact of soft intervention on the Chinese financial futures market

During the 2015 financial crisis in China, participants faced the criticism that manipulators and shorts had destabilized the market. As a result, the Chinese Securities Regulatory Commission intervened sequentially in the spot market and then in the futures market. Trading volume dropped precipitously. Using the cost-of-carry model, we find that these actions significantly impacted equilibrium pricing. Following intervention in the spot market, mispricing was attenuated but remained significant after further intervention in the futures market. We use the Hong Kong market and a difference-in-differences statistic to address the role of the China Securities Regulatory Commission soft intervention versus intervention by hard rules.     

Short selling,unwinding, and mispricing

This article highlights the impact of short selling restrictions and early unwinding opportunities on the relation between futures and spot prices. Within a multiperiod equilibrium model, the influence of optimal arbitrage trading on the mispricing is analyzed. Results concerning trade volume and level, mean reversion, and path dependence of the mispricing are provided. The empirical evidence suggests that short selling restrictions and early unwinding opportunities are influential factors for the mispricing behavior. They help explain empirical findings reported in the literature. © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:903–923, 1998     

The profitability of index futures arbitrage: Evidence from bid-ask quotes

Previous studies investigated the profitability of stock index futures based on transaction price data, and could overstate the frequency of arbitrage opportunities and size of arbitrage profits. This article obtains a data base for the Hong Kong index futures and index options market that contains both real-time transaction prices and bid-ask quotes; the article further examines the bias of identifying arbitrage opportunities based on transaction prices. The article finds the percentage of observations violating no-arbitrage bounds is significantly reduced when bid-ask quotes are employed instead of transaction prices. This suggests studies that implement arbitrage strategies based on transaction prices employ prices from the wrong side of the spread. This article finds a relationship between the frequency of violations (evaluated from transaction prices) and the size of bid-ask spreads in the futures and options markets. This phenomenon indicates that a larger mispricing, which may arise when the bid-ask spread is wider, does not necessarily imply profitable arbitrage opportunity. © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:743–763, 1998     

The pricing of stock index futures spreads at contract expiration

This paper conducts an empirical analysis of the mispricing of calendar spreads for stock index futures. Using recent data drawn from the Sydney Futures Exchange, a sharp increase in the magnitude of spread mispricing immediately prior to maturity of the near contract is documented. This pattern in mispricing is related to a sharp decline in open interest in the near contract and an increase in open interest in the deferred contract. Further, the direction of mispricing of the near and deferred contracts are more likely to move in opposite directions as the near contract approaches maturity. These findings are consistent with the hypothesis that traders seeking to roll‐over their positions from near to deferred futures contracts close to maturity increase the magnitude of spread mispricing. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:451–469, 2002     

The Hong Kong Equity Market and an Institutional Framework for Asset Pricing

Given the potential implications of market structure for asset pricing, this paper examines the structural and institutional features of the Hong Kong equity market and their relevance to explaining market behaviour. It was found that the Hong Kong market appears less perfect and hence less efficient than their counterparts in the more developed economies, such as the USA and the UK, so that market disequilibrium and asset mispricing might have occurred. This paper adds value to the literature as the findings provide an institutional framework for analysing and explaining the results from empirical asset pricing work, past and future, on the Hong Kong market. This has far-reaching implications for financial decisions.     

The limits to stock index arbitrage: Examining S&P 500 futures and SPDRS

This study examines factors affecting stock index spot versus futures pricing and arbitrage opportunities by using the S&P 500 cash index and the S&P 500 Standard and Poor's Depository Receipt (SPDR) Exchange‐Traded Fund (ETF) as “underlying cash assets.” Potential limits to arbitrage when using the cash index are the staleness of the underlying cash index, trading costs, liquidity (volume) issues of the underlying assets, the existence of sufficient time to execute profitable arbitrage transactions, short sale restrictions, and the extent to which volatility affects mispricing. Alternatively, using the SPDR ETF as the underlying asset mitigates staleness and trading cost problems as well as the effects of volatility associated with the staleness of the cash index. Minute‐by‐minute prices are compared over different volatility levels to determine how these factors affect the limits of S&P 500 futures arbitrage. Employing the SPDR as the cash asset examines whether a liquid tradable single asset with low trading costs can be used for pricing and arbitrage purposes. The analysis examines how long mispricing lasts, the impact of volatility on mispricing, and whether sufficient volume exists to implement arbitrage. The minute‐by‐minute liquidity of the futures market is examined using a new transaction volume futures database. The results show that mispricings exist regardless of the choice of the underlying cash asset, with more negative mispricings for the SPDR relative to the S&P 500 cash index. Furthermore, mispricings are more frequent in high‐ and mid‐volatility months than in low‐volatility months and are associated with higher volume during high‐volatility months. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:1182–1205, 2008     

Determinants of Nikkei futures mispricing in international markets: Dividend clustering,currency risk,and transaction costs

This paper develops a comprehensive modified cost-of-carry model to study the mispricing of Nikkei 225 index futures contracts traded in Osaka, Singapore, and Chicago based on a new 19-year data set. Using this improved model, we find that dividend clustering, currency risk, and transaction costs all play an essential role in the estimation of Nikkei mispricing. An exponential smooth transition autoregressive-GARCH model is used to describe the international dynamics of Nikkei mispricing. The results indicate that generally mean reversion in mispricing and limits to arbitrage are driven more by transaction costs than by heterogeneous investors.     

Standard and Poor’s depository receipts and the performance of the S&P 500 index futures market

In response to the need for a simple financial instrument that enables retail investors to participate easily and quickly in the U.S. equity market and that facilitates basket trading by institutions, the American Stock Exchange introduced Standard and Poor’s Depository Receipts (SPDRs) on January 29, 1993. The purpose of this study is to determine the effects of the introduction of SPDRs on the pricing efficiency of the S&P futures market. Using a measure of efficiency that is based on the difference between the observed futures price and the theoretical futures price based on the Cost of Carry Model, as well as daily and intradaily data for the period January 2, 1990 through June 3, 1996, we found that some positive mispricing was reduced when SPDR’s were introduced. While dividend yield and time‐to‐maturity biases remained, SPDRs trading was shown to mitigate the extent of pricing errors that prevailed, and reduced the effects of dividend yield and time‐to‐maturity biases found for these contracts. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:705–716, 2000     

Cross-market efficiency in the Indian derivatives market: A test of put–call parity

This study examines the cross-market efficiency of the Indian options and futures market using model-free tests. The put–call–futures and put–call–index parity conditions are tested for European style Nifty Index options. Thirty-five-month time-stamped transactions data are used to identify mispricing. Frequent violations of both forms of put–call parity are observed. The restriction on short sales largely accounts for the put–call–index parity violations. There are numerous put–call–futures arbitrage profit opportunities even after accounting for transaction costs, which vanish quickly. Put options are overpriced more often than call options. The mispricing shows specific patterns with respect to time of the day, moneyness, volatility, and days to expiry. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:889–910, 2008     

Market microstructure effects on volatility at the TAIFEX

This study examines whether changes in the frequency of market clearing or changes in trading hours on competing exchanges that use different auction systems affect the volatility of futures prices. In particular, this study exploits a natural experiment in the frequency of market clearing of stock index futures contracts traded on the Taiwan Futures Exchange (TAIFEX) to assess whether successive increases in the frequency of market clearing are associated with changes in the volatility of futures prices. The impact of changes in the trading hours on the TAIFEX and on the competing Singapore Exchange (SGX) where a similar Taiwanese stock index futures contract trades under a continuous auction market regime is also examined. The evidence for the impact of an increase in the frequency of market clearing on volatility is mixed. However, the introduction of simultaneous opening times for the TAIFEX (which batches orders at the open) and the SGX (which does not) is associated with a significant reduction in the volatility in SGX Taiwanese stock index futures prices. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:1219–1243, 2007     

The pricing of electricity futures: Evidence from the European energy exchange

This study investigates the pricing of electricity futures at the European Energy Exchange (EEX) over the period 2002 through 2004. To calculate theoretical contract values, the reduced‐form models of J. J. Lucia and E. S. Schwartz (2002) are used, and a thorough empirical analysis by means of an out‐of‐sample test is conducted for both one‐ and two‐factor models, incorporating a constant non‐zero price of risk. Although the models are proven to capture all basic spot market characteristics and provide an accurate in‐the‐sample fit to observed futures prices, the forecasting performance is subject to biases. For instance, it was found that the relative mispricing depends on both the spot price level and the remaining time‐to‐maturity of the futures contracts. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:387–410, 2007     

The Chinese warrant bubble: A fundamental analysis

We investigate the information content in Chinese warrant prices based on an option pricing framework that incorporates short‐selling and margin‐trading constraints in the underlying stock market. We show that Chinese warrant prices can be explained under this pricing framework. On the basis of this new model, we develop a price deviation measure to quantify stock market investors' unobserved demand for short selling or margin trading due to market constraints. We find that warrant‐price deviations are driven by underlying stock valuation to a great extent. Chinese warrant prices, save for the time around expiration dates, are better characterized as derivatives than as pure bubbles.     

The Valuation of Equity Futures on the Tokyo Stock Exchange: 1920–1923

The futures price of an asset should depend on the spot price of that asset, the interest rate, cash flows during the contract term, the convenience yield, and storage costs. Despite many tests of the spot–future relation for commodities in historical periods, there have been no tests of this historical relation for equities. We price single‐stock equity futures on the Tokyo Stock Exchange between 1920 and 1923 and find that mispricing is considerably worse than in contemporary U.S. markets, after adjusting for (unavoidable) asynchronous data issues. The main cause of the mispricing is short‐sales constraints, rather than investor naivety. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark     

Are single stock futures used as an alternative during a short‐selling ban?

The response of the single stock futures (SSF) market to a short‐selling ban is investigated. The hypothesis is that traders use SSF as a substitute instrument for short‐selling. A significant increase in SSF trading activity is documented, accompanied by narrower spreads. SSF market volatility did not react during the ban, which suggests that the increased trading activity did not weaken SSF market quality. The quality of the underlying market during the ban period is also assessed, with the results suggesting that changes in SSF market activity had neither positive nor negative effects on the stocks’ liquidity, volatility, and volume.     

Business and the rule of law in Hong Kong

Hong Kong's fair efficient legal system is the bedrock of its economic success. The practice of Western law underpins Hong Kong's entire free, market by providing a level playing field, due process, protection of property right and legal contracts. Mr. Lee, the Democratric Party of Hong Kong, warns of the potential harmful impact of Chinese sovereignty in Hong Kong after 1997, particularly through corruption and nepotism.     

The information content of option implied volatility surrounding the 1997 Hong Kong stock market crash

This study examines the information conveyed by options and examines their implied volatility at the time of the 1997 Hong Kong stock market crash. The author determines the efficiency of implied volatility as a predictor of future volatility by comparing it to other leading indicator candidates. These include volume and open interest of index options and futures, as well as the arbitrage basis of index futures. Using monthly, nonoverlapping data, the study reveals that implied volatility is superior to those variables in forecasting future realized volatility. The study also demonstrates that a simple signal extraction model could have produced useful warning signals prior to periods of extreme volatility. These results indicate that the options market is highly efficient informationally. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:555–574, 2007