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Order Imbalance and the Pricing of Index Futures

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Author Info
Joseph K.W. Fung (Hong Kong Baptist University)
Abstract

This study examines whether the direction and magnitude of the aggregate order-imbalance of the index stocks can explain the arbitrage spread between index futures and the underlying cash index. The data are for the Asian financial crisis period and hence entail wide variations in order imbalance and the index-futures basis. The analysis controls for realistic trading costs and actual dividend payments. The results indicate that the arbitrage spread is positively related to the aggregate order imbalance in the underlying index stocks; negative order-imbalance has a stronger impact than positive order imbalance. Violations of the upper no-arbitrage bound are related to positive order imbalance and violations of the lower no-arbitrage bound are related to negative order imbalance. Asymmetric response times to negative and positive spreads can be attributed to the difficulty, cost, and risk of short stock arbitrage when the futures is below its no-arbitrage value. The significant relationship between order imbalance and arbitrage spread confirm that index arbitrageurs are important providers of liquidity in the futures market when the stock market is in disequilibrium.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 132006.

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Length: 24 pages
Date of creation: Oct 2006
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Handle: RePEc:hkm:wpaper:132006

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  3. Joseph K. W. Fung & Li Jiang, 1999. "Restrictions on Short-Selling and Spot-Futures Dynamics," Journal of Business Finance & Accounting, Blackwell Publishing, vol. 26(1-2), pages 227-248. [Downloadable!] (restricted)
  4. Kleidon, Allan W & Whaley, Robert E, 1992. " One Market? Stocks, Futures, and Options during October 1987," Journal of Finance, American Finance Association, vol. 47(3), pages 851-77, July. [Downloadable!] (restricted)
  5. 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. [Downloadable!]
  6. Harris, Lawrence & Sofianos, George & Shapiro, James E, 1994. "Program Trading and Intraday Volatility," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 7(4), pages 653-85. [Downloadable!] (restricted)
  7. Kleidon, Allan W, 1992. "Arbitrage, Nontrading, and Stale Prices: October 1987," Journal of Business, University of Chicago Press, vol. 65(4), pages 483-507, October. [Downloadable!] (restricted)
  8. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-46, June. [Downloadable!] (restricted)
  9. David Easley & Maureen O'Hara & P.S. Srinivas, 1998. "Option Volume and Stock Prices: Evidence on Where Informed Traders Trade," Journal of Finance, American Finance Association, vol. 53(2), pages 431-465, 04. [Downloadable!] (restricted)
  10. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," Journal of Business, University of Chicago Press, vol. 61(3), pages 275-98, July. [Downloadable!] (restricted)
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  11. Miller, Merton H & Muthuswamy, Jayaram & Whaley, Robert E, 1994. " Mean Reversion of Standard & Poor's 500 Index Basis Changes: Arbitrage-Induced or Statistical Illusion?," Journal of Finance, American Finance Association, vol. 49(2), pages 479-513, June. [Downloadable!] (restricted)
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