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

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Brooks, C. and Garrett, I. (2002) Can we explain the dynamics of the UK FTSE 100 stock and stock index futures markets? Applied Financial Economics, 12 (1). pp. 25-31. ISSN 1466-4305

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To link to this article DOI: 10.1080/09603100110087996

Abstract/Summary

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.

Item Type:Article
Refereed:Yes
Divisions:Henley Business School > ICMA Centre
ID Code:24155
Uncontrolled Keywords:stock index, stock index futures, arbitrage, basis, error correction, nonlinearity, threshold, regime, SETAR models
Publisher:Taylor & Francis

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