Analysis of DJIA,S&P 500, S&P 400, NASDAQ 100 and Russell 2000 ETFs and their influence on price discovery

This study examines the temporal behavior of price discovery in the spot, ETF and futures markets of the DJIA, S&P 500, S&P 400, NASDAQ 100 and Russell 2000. We document an increasing trend in the price discovery metrics of exchange traded funds for all indexes but the DJIA. Contrary to past studies, our findings show that the spot market rather than the futures market leads the price discovery. The arbitrage process that links exchange traded funds to spot prices, and not the futures prices might explain the results. This daily arbitrage that ensures exchange traded funds prices equal net asset values appear to promote spot market price discovery especially with the popularity of exchange traded funds in more recent years. We additionally document that the temporal behavior of the exchange traded funds price discovery metric affects differently price discovery in the spot and futures markets across indexes.     

Feedback trading in stock index futures: Evidence from South Africa

This study tests whether investors and speculators in stock index futures contracts on the South African stock market use feedback trading strategies. Feedback trading can be destabilizing and impede on the risk mitigation and price discovery functions of futures contracts. Using the Sentana and Wadhwani (1992) model, and accounting for the global financial crisis, we find no evidence of feedback trading in the Top40 futures index or the Top40 mini futures index contracts. Our findings have important implications for investors who wish to use index futures to mitigate risk or exploit arbitrage opportunities and regulators concerned about the destabilizing effects of futures trading.     

An alternative approach to evaluating the agreement between financial markets

This research investigates that the price relationship between a stock index and its associated nearby futures markets can be explained by the cost-of-carry model using the concordance correlation (CC) coefficient in the US financial markets. The main purpose of this research is to confirm that the CC coefficient is an appropriate methodology to determine ex post arbitrage opportunities and to maximize ex ante arbitrage profits through the analysis of the price relationship derived from the cost-of-carry model. To increase the robustness of the results and to enable us to generalize our conclusions, this analysis is carried out in consideration of external uncertainty, including the marking-to-market procedure of futures contracts and the transaction cost on the stock index and its futures markets, under several assumptions related to the conditions of transactions. Examining transaction price data on the S&P 500 stock index and its futures markets shows that the CC coefficient gives a good result for ex ante arbitrage profits and is appropriate for analyzing the relationship between the observed stock index futures market price and its theoretical price derived from the cost-of-carry model.     

Examining the Equilibrium Relationship Between the Shanghai 50 Stock Index Futures and the Shanghai 50 ETF Options Markets

Based on the put-call-futures parity model, this article studies the equilibrium relationship between the Shanghai 50 stock index futures and the Shanghai 50 Exchange-Traded Fund (ETF) options markets by analyzing the arbitrage opportunities and profits between these two derivative markets. This article reveals that the cost spread, option volatility, days from the expiration date, moneyness of options, trading strategy, and policy factors all have a great impact on the arbitrage profits and opportunities. In addition, significant arbitrage profits and opportunities indicate violations of put-call-futures parity. Although no equilibrium relationship exists between the Shanghai 50 stock index futures and the Shanghai 50 ETF options markets, efficiency in these markets has gradually improved.     

Evidence on the arbitrage efficiency of SPI index futures and options markets

This paper is concerned with arbitrage opportunities in the futures and futures option contracts traded on the Sydney Futures Exchange (SFE) within a put-call-futures-parity (PCFP) framework. Tick-by-tick transaction price data are employed so that the futures contracts, the call futures options and the put futures options can be matched within a one-minute interval. This paper also takes into account the realistic transaction costs that an arbitrager has to incur, including the implicit bid-ask spread. A thorough ex post analysis is first carried out. The results reveal a significant number of violations of the PCFP in the sample. Ex ante tests are then conducted whereby ex post profitable arbitrage strategies, signified by the matched trios of futures, put and call contracts, are executed with lags up to 3 min. The ex ante results are similar to the ex post results. However, further analysis reveals that the exploitability of the identified arbitrage opportunities is very limited due to the small trading volumes of the futures and options contracts. Thus, we conclude that there is no strong evidence against the arbitrage efficiency between the SPI index futures and options markets in Australia.      

Trading activity and price discovery in Bitcoin futures markets

This study examines the impact of trading activities on price discovery in the Bitcoin futures markets. We find that trades of hedgers are positively correlated with the modified information shares in both CME and CBOE futures markets, suggesting that their trading promotes futures market efficiency. Retailers’ trading activity relates negatively to the price discovery of the CME Bitcoin futures and thus destabilizes the market. Speculators exert positive (negative) impact on the price discovery in the CME (CBOE) Bitcoin futures. Our finding that CME’s Bitcoin futures exhibit superior price discovery than CBOE’s provides plausible justification for CBOE’s decision in March 2019 to suspend further listings of Bitcoin futures contracts.     

Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market

We study the impact of algorithmic trading (AT) in the foreign exchange market using a long time series of high‐frequency data that identify computer‐generated trading activity. We find that AT causes an improvement in two measures of price efficiency: the frequency of triangular arbitrage opportunities and the autocorrelation of high‐frequency returns. We show that the reduction in arbitrage opportunities is associated primarily with computers taking liquidity. This result is consistent with the view that AT improves informational efficiency by speeding up price discovery, but that it may also impose higher adverse selection costs on slower traders. In contrast, the reduction in the autocorrelation of returns owes more to the algorithmic provision of liquidity. We also find evidence consistent with the strategies of algorithmic traders being highly correlated. This correlation, however, does not appear to cause a degradation in market quality, at least not on average.     

Price discovery and volatility spillovers in the European Union emissions trading scheme: A high-frequency analysis

This paper models the relationship of European Union Allowance spot- and futures-prices within the second commitment period of the European Union emissions trading scheme. Based on high-frequency data, we analyze the transmission of information in first and second conditional moments. To reveal long-run price discovery, we compute common factor weights of Schwarz and Szakmary (1994) and information shares of Hasbrouck (1995) based on estimated coefficients of a VECM. To analyze the short-run dynamics, we perform Granger-causality tests. We identify the futures market to be the leader of the long-run price discovery process, whereas the informational role of the futures market increases over time. In addition, we employ a version of the UECCC-GARCH model as introduced by Conrad and Karanasos (2010) to analyze the volatility transmission structure. The volatility analysis indicates a close relationship between the volatility dynamics of both markets, whereas in particular we observe spillovers from the futures to the spot market. As a whole the investigation reveals that the futures market incorporates information first and then transfers the information to the spot market.     

Arbitrage,Continuous Trading,and Margin Requirements

This paper studies the impact that margin requirements have on both the existence of arbitrage opportunities and the valuation of call options. In the context of the Black-Scholes economy, margin restrictions are shown to exclude continuous-trading arbitrage opportunities and, with two additional hypotheses, still to allow the Black-Scholes call model to apply. The Black-Scholes economy consists of a continuously traded stock with a price process that follows a geometric Brownian motion and a continuously traded bond with a price process that is deterministic.     

Intraday Price Discovery in the DJIA Index Markets

Abstract:  This paper explores the dynamics of price discovery between the Dow Jones Industrial Average (DJIA) index and its three derivative products: the DIAMOND exchange-traded fund (ETF), the floor-traded regular futures, and the electronically traded mini futures. Even though the American Stock Exchange is the primary listing exchange for the ETF, the analysis indicates that the electronically traded ETF on the Archipelago (ArcaEx) electronic communications network dominates the price discovery process for DIAMOND shares. The E-mini futures contribute the most to price discovery, followed by the ArcaEx DIAMOND. The DJIA index and regular futures contribute least to price discovery. The analysis is repeated using the derivatives of the S&P 500 index as a robustness check. The results indicate that multi-market trading ensures greater pricing efficiency. Informed traders favor electronic trading because of immediate and anonymous trade execution.     

An analysis of time-varying commodity market price discovery

We propose a model of time-varying price discovery based on a rolling-window error correction framework. We show that price discovery in nine commodities is dominated by the spot market, while, in only six commodities, price discovery is dominated by the futures market. Our findings, therefore, challenge the well-established view in commodity markets that it is the futures market which dominates the price discovery process. We also show the economic significance of price discovery through a portfolio construction and hedging strategy.     

The effectiveness of position limits: Evidence from the foreign exchange futures markets

This study considers the effects of the relative size of hedger and speculator open interests and the potential impact of implementing position limits on the price discovery process in both JPY–USD and EUR–USD futures markets. Hedging trading exerts a negative impact, regardless of its size, on price discovery in futures markets. Hedgers are less likely to be information motivated, so their trading uniformly delays the price discovery process. However, there is a positive and nonlinear impact of speculators’ trade size on price discovery, the contribution of which depends on the relative size of the speculative open interest. Contrary to conventional wisdom among regulators, speculative trading does not harm the market in terms of market efficiency; as long as the percentage of speculators’ open interest is below an endogenously determined threshold (approximately 20% for EUR–USD and 16.3% for JPY–USD), speculative trading even improves futures market efficiency.     

The day the index rose 11 %: a clinical study on price discovery reversal

On October 28, 2008, Germany’s leading equity index Deutscher Aktienindex (DAX) rose 11.28 % which is the highest daily performance since its inception. That day, the arbitrage relationship between the cash and the futures market broke down. Based on this clean natural experiment, we examine price innovation dynamics of DAX related spot products for the days surrounding the event day. We find that price discovery is strongly reversed during the extreme event day with futures losing their common leadership to less liquid index certificates of market leading issuers. Evidently, strategic quote setting of certificate issuers drives the negative futures spot basis. An important broader implication from our research is that such an event is not unlikely to reoccur in the future. Although the Deutsche Börse AG calculating the DAX has reconsidered its rules since then, 30 out of 49 leading indices around the world do not include a relative weight cap. When the number of included firms is additionally low, the odds of another “Volkswagen event” increase. 14 out of the 30 uncapped indices include less than 50 firms.     

Investor structure and the informational efficiency of commodity futures prices

This article investigates the impact of the trading positions of hedgers (i.e., producers, merchants, processors, or users of a commodity), speculators (i.e., commodity pool operators, trading advisors, or hedge funds), and swap dealers on the price formation process in the agricultural, metal, and energy futures markets. The hedgers' relative positions exert negative impacts on price efficiency in commodity futures markets. Hedgers are less likely to be information motivated, so their trading delays the price formation process. However, speculators' positions have positive impacts on price efficiency because speculators correct pricing errors. This study also offers evidence that the role of swap dealers, similar to speculators in futures markets, is to provide liquidity and cross-market arbitrage. These findings highlight the role of producers, hedge funds, and swap dealers in price formation processes in commodity futures—information that is beneficial to academics, practitioners, and regulators.     

A liquidity-based model for asset price bubbles

We provide a new liquidity-based model for financial asset price bubbles that explains bubble formation and bubble bursting. The martingale approach to modeling price bubbles assumes that the asset's market price process is exogenous and the fundamental price, the expected future cash flows under a martingale measure, is endogenous. In contrast, we define the asset's fundamental price process exogenously and asset price bubbles are endogenously determined by market trading activity. This enables us to generate a model that explains both bubble formation and bubble bursting. In our model, the quantity impact of trading activity on the fundamental price process—liquidity risk—is what generates price bubbles. We study the conditions under which asset price bubbles are consistent with no arbitrage opportunities and we relate our definition of the fundamental price process to the classical definition.     

Price Expectation and the Pricing of Stock Index Futures

Capital markets are not perfect or frictionless, and arbitrage mechanism cannot be complete, particularly for index arbitrage. This study constructs a theoretical foundation to explain why the price expectation of the underlying asset should be entered into the pricing formula of stock index futures. The price expectation and incompleteness of arbitrage then are taken into account to develop a pricing model of stock index futures in imperfect markets. This study also presents three approaches for estimating the model parameter. Finally, the concept of the degree of market imperfection is defined and the valuation model is provided.     

Price limits in futures markets: effects on the price discovery process and volatility

Price limits are actively employed by many futures exchanges as a regulatory mechanism directed at reducing volatility and improving price discovery process. The aim of this paper is to investigate whether price limits achieve these goals without affecting market liquidity for a number of agricultural futures contracts. We employ models of changing volatility in order to show that price limits do not appear to significantly reduce market volatility. In addition, we find evidence confirming the hypothesis that price limits delay price discovery instead of facilitating it. Our results also suggest that the impact of price limits on volatility and price reversals, found in previous studies, are mainly due to the properties inherent to the futures returns, such as volatility clustering. Finally, although trading decreases significantly due to the price limits, traders do not seem to switch from the contracts affected by price limits to other maturities in order to minimize the impact of circuit breakers.     

Large traders,hidden arbitrage,and complete markets

This paper studies hidden arbitrage opportunities in markets where large traders affect the price process, and where the market is complete (in the classical sense). The arbitrage opportunities are “hidden” because they occur on a small set of times (typically of Lebesgue measure zero). These arbitrage opportunities occur naturally in markets where a large trader supports the price of some asset or commodity, for example corporate stock repurchase plans, government interest rate or foreign currency intervention, and price support by investment banks in IPOs. We also illustrate immediate arbitrage opportunities generated by usual market activity at specific points in time, for example the issuance date of an IPO or the inclusion date of a new stock in the S&P 500 index.     

Index Options-Futures Arbitrage: A Comparative Study with Bid/Ask and Transaction Data

We can infer from bid/ask quotations and transaction prices that where options contracts are traded under a competitive open‐outcry market‐making system, the options and futures markets are dynamically efficient. Ex‐ante analysis shows that potential arbitrage opportunities disappear within five minutes. Transaction price data understate both the frequency and magnitude of arbitrage opportunities that are signaled by bid/ask quotes. Quotes stale fast, so opportunities are short‐lived and some of the arbitrage opportunities are deceptive. Nonetheless, the evidence suggests that bid/ask quotes provide valuable trading signals to arbitrageurs. Profitability from exploiting the quotes is negatively related to execution delay and execution risk.     

Index arbitrage with heterogeneous investors: A smooth transition error correction analysis

The traditional index arbitrage model assumes a constant threshold mispricing between the futures and cash prices for all investors. Allowing for heterogeneity in investors' transaction costs, objectives, and capital constraints, we model the intraday mispricing of DJIA futures as a smooth transition autoregressive (STAR) process with the speed of adjustment toward equilibrium varying directly with the mispricing. We show that the observed mean reversion in mispricing changes is induced by heterogeneous arbitrageurs, instead of a statistical illusion-infrequent trading of index portfolio stocks. We further use a STAR error correction model to describe the nonlinear dynamics between the DJIA futures and index. This model describes not only which market is more informationally efficient than the other, but also the legging process – the nonsimultaneous establishing of cash and futures positions.