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Information contents misjudged: Digressive convergence to equilibrium in cointegrated prices

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  • Tswei, Keshin
  • Lai, Jing-yi
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    Abstract

    The spot price on the Taiwan stock index is richer in information than the futures price judged by the price discovery measures of Gonzalo and Granger [Gonzalo, J., & Granger, C.W.J. (1995). Estimation of common long-memory components in cointegrated systems. Journal of Business and Economic Statistics, 13, 27-35.] and Hasbrouck [Hasbrouck, J. (1995). One security, many markets: Determining the contributions to price discovery. Journal of Finance, 50, 1175-1199.]. What is special about the markets is that both the spot and futures error-correction coefficients are positive, implying a digressive convergence to their long-run equilibrium in the error-correction (EC) process. Innovation accounting suggests that the cause of this digressive equilibrium adjustment is that investors systematically overreact to news in the less informative futures market but under-react to the more informative spot market. Our contribution is in identifying the digressive convergence implied by same-sign EC coefficients, comparing it to the normal convergence widely found in opposite-sign EC models, and providing short-run mispricing interpretations for both types of convergence to equilibrium.

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    Bibliographic Info

    Article provided by Elsevier in its journal Review of Financial Economics.

    Volume (Year): 18 (2009)
    Issue (Month): 4 (October)
    Pages: 183-189

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    Handle: RePEc:eee:revfin:v:18:y:2009:i:4:p:183-189

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    Web page: http://www.elsevier.com/locate/inca/620170

    Related research

    Keywords: Price discovery Overreaction Error correction;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Erik Theissen, 2001. "Price Discovery in Floor and Screen Trading Systems," Bonn Econ Discussion Papers bgse35_2001, University of Bonn, Germany.
    2. Fong, Kingsley & Zurbruegg, Ralf, 2003. "How much do locals contribute to the price discovery process?," Journal of Empirical Finance, Elsevier, vol. 10(3), pages 305-320, May.
    3. Kate Phylaktis & Gikas Manalis, 2005. "Price transmission dynamics between informationally linked securities," Applied Financial Economics, Taylor & Francis Journals, vol. 15(3), pages 187-201.
    4. Hasbrouck, Joel, 1995. " One Security, Many Markets: Determining the Contributions to Price Discovery," Journal of Finance, American Finance Association, vol. 50(4), pages 1175-99, September.
    5. Garbade, Kenneth D & Silber, William L, 1983. "Price Movements and Price Discovery in Futures and Cash Markets," The Review of Economics and Statistics, MIT Press, vol. 65(2), pages 289-97, May.
    6. Zhong, Maosen & Darrat, Ali F. & Otero, Rafael, 2004. "Price discovery and volatility spillovers in index futures markets: Some evidence from Mexico," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3037-3054, December.
    7. Frank de Jong, 2001. "Measures of Contributions to Price Discovery: A Comparison," Tinbergen Institute Discussion Papers 01-114/2, Tinbergen Institute.
    8. Harris, Frederick H. deB. & McInish, Thomas H. & Wood, Robert A., 2002. "Common factor components versus information shares: a reply," Journal of Financial Markets, Elsevier, vol. 5(3), pages 341-348, July.
    9. deB. Harris, Frederick H. & McInish, Thomas H. & Shoesmith, Gary L. & Wood, Robert A., 1995. "Cointegration, Error Correction, and Price Discovery on Informationally Linked Security Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(04), pages 563-579, December.
    10. Gonzalo, Jesus & Granger, Clive W J, 1995. "Estimation of Common Long-Memory Components in Cointegrated Systems," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(1), pages 27-35, January.
    11. Foster, Andrew J., 1996. "Price discovery in oil markets: a time varying analysis of the 1990-1991 Gulf conflict," Energy Economics, Elsevier, vol. 18(3), pages 231-246, July.
    12. Kim, Ki-ho, 2003. "Dollar exchange rate and stock price: evidence from multivariate cointegration and error correction model," Review of Financial Economics, Elsevier, vol. 12(3), pages 301-313.
    13. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
    14. Yiuman Tse & Grigori Erenburg, 2003. "Competition For Order Flow, Market Quality, And Price Discovery In The Nasdaq 100 Index Tracking Stock," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 26(3), pages 301-318.
    15. Su, Qian & Chong, Terence Tai-Leung, 2007. "Determining the contributions to price discovery for Chinese cross-listed stocks," Pacific-Basin Finance Journal, Elsevier, vol. 15(2), pages 140-153, April.
    16. Tse, Yiuman & Lee, Tae-Hwy & Booth, G. Geoffrey, 1996. "The international transmission of information in Eurodollar futures markets: a continuously trading market hypothesis," Journal of International Money and Finance, Elsevier, vol. 15(3), pages 447-465, June.
    17. Stoll, Hans R. & Whaley, Robert E., 1990. "The Dynamics of Stock Index and Stock Index Futures Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(04), pages 441-468, December.
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    Cited by:
    1. Fricke, Christoph & Menkhoff, Lukas, 2011. "Does the "Bund" dominate price discovery in Euro bond futures? Examining information shares," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1057-1072, May.

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