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Can we explain the dynamics of the UK FTSE 100 stock and stock index futures markets?

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  • Chris Brooks
  • Ian Garrett

Abstract

If stock and stock index futures markets are functioning properly price movements in these markets should best be described by a first order vector error correction model with the error correction term being the price differential between the two markets (the basis). Recent evidence suggests that there are more dynamics present than should be in effectively functioning markets. Using self-exciting threshold autoregressive (SETAR) models, this study analyses whether such dynamics can be related to different regimes within which the basis can fluctuate in a predictable manner without triggering arbitrage. These findings reveal that the basis shows strong evidence of autoregressive behaviour when its value is between the two thresholds but that the extra dynamics disappear once the basis moves above the upper threshold and their persistence is reduced, although not eradicated, once the basis moves below the lower threshold. This suggests that once nonlinearity associated with transactions costs is accounted for, stock and stock index futures markets function more effectively than is suggested by linear models of the pricing relationship.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 12 (2002)
Issue (Month): 1 ()
Pages: 25-31

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Handle: RePEc:taf:apfiec:v:12:y:2002:i:1:p:25-31

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Cited by:
  1. David G. McMillan, 2009. "Non-linear interest rate dynamics and forecasting: evidence for US and Australian interest rates," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 14(2), pages 139-155.
  2. Chin-Ping King, 2012. "Half Life of the Real Exchange Rate: Evidence from the Nonlinear Approach in Emerging Economies," Journal of Economics and Management, College of Business, Feng Chia University, Taiwan, vol. 8(1), pages 1-23, January.
  3. Coakley, Jerry & Fuertes, Ana-Maria, 2006. "Valuation ratios and price deviations from fundamentals," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2325-2346, August.
  4. McMillan, David G., 2009. "Forward interest rate premium and asymmetric adjustment: Evidence from 16 countries," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 19(2), pages 258-273, April.
  5. David McMillan, 2008. "Non-linear cointegration and adjustment: an asymmetric exponential smooth-transition model for US interest rates," Empirical Economics, Springer, vol. 35(3), pages 591-606, November.
  6. Huang, Bwo-Nung & Yang, C.W. & Hwang, M.J., 2009. "The dynamics of a nonlinear relationship between crude oil spot and futures prices: A multivariate threshold regression approach," Energy Economics, Elsevier, vol. 31(1), pages 91-98, January.
  7. Cathy Chen & Shu-Yu Chen & Sangyeol Lee, 2013. "Bayesian Unit Root Test in Double Threshold Heteroskedastic Models," Computational Economics, Society for Computational Economics, vol. 42(4), pages 471-490, December.

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