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Role of the Futures Market on Volatility and Price Discovery of the Spot Market: Evidence from Pakistan’s Stock Market

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  • Safi Ullah Khan

Abstract

This paper focuses on the role of the financial futures market in the volatility of Pakistan’s stock market and determines whether the stock futures price is capable of providing some relevant information for predicting the spot price. The Generalized Autoregressive Conditional Heteroscedasticity (GARCH) approach isused to measure volatility in the spot and the futures market and to analyze the relationships between spot and futures market volatility. Causalityand feedback relationships between the two markets are analyzed and determined through the Vector Error Correction Model (VECM). Empirical results support the evidence that spot prices generally lead the futures pricesin incorporating new information, and that volatility in the futures market does not increase volatility in the spot market. Rather the study finds more consistent support for the alternative hypothesis that volatility in the futures market may be an outgrowth of the volatile spot market.

Suggested Citation

  • Safi Ullah Khan, 2006. "Role of the Futures Market on Volatility and Price Discovery of the Spot Market: Evidence from Pakistan’s Stock Market," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 11(2), pages 107-121, Jul-Dec.
    • Handle: RePEc:lje:journl:v:11:y:2006:i:2:p:107-121
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    References listed on IDEAS

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    1. Anand K. Bhattacharya & Anju Ramjee & Balasubramani Ramjee, 1986. "The causal relationship between futures price volatility and the cash price volatility of GNMA securities," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 6(1), pages 29-39, March.
    2. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    3. Akgiray, Vedat, 1989. "Conditional Heteroscedasticity in Time Series of Stock Returns: Evidence and Forecasts," The Journal of Business, University of Chicago Press, vol. 62(1), pages 55-80, January.
    4. Andreas Pericli & Gregory Koutmos, 1997. "Index futures and options and stock market volatility," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 17(8), pages 957-974, December.
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    Cited by:

    1. Imran Riaz MALIK* & Attaullah SHAH*, 2014. "Market Varying Conditional Risk-Return Relationship," Pakistan Journal of Applied Economics, Applied Economics Research Centre, vol. 24(2), pages 121-142.
    2. Shah, Mohay Ud Din & Shah, Attaullah & Khan, Safi Ullah, 2017. "Herding behavior in the Pakistan stock exchange: Some new insights," Research in International Business and Finance, Elsevier, vol. 42(C), pages 865-873.
    3. Muthucattu Thomas Paul, 2018. "The Issues and Implications About the Volatility of the Stock and the Bond Prices and Their Returns and the Volatility of Interest Rates and Inflation - Which Are Being Researched in Finance and Macro," Applied Economics and Finance, Redfame publishing, vol. 5(2), pages 125-142, March.
    4. Imran Riaz Malik & Attaullah Shah, 2016. "Resumption of Single Stock Futures (SSFs) with Stringent Regulations and their Impact on the Risk Characteristics of the Underlying Stocks," Business & Economic Review, Institute of Management Sciences, Peshawar, Pakistan, vol. 8(2), pages 1-22, October.

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