IGIDR Working Paper: When do stock futures dominate price discovery?  



Author:Nidhi Aggarwal and Susan Thomas

Title:When do stock futures dominate price discovery?


Stock futures offer leveraged positions and are expected to attract informed traders. However, many researchers have found that the information share of the stock futures is surprisingly small; the equity spot market appears to play a large role in price discovery. In this paper, we investigate this phenomenon and offer two findings. First, liquidity of the stock futures plays a major role in influencing price discovery. The securities where the spot market plays a major role tend to be those with illiquid stock futures. The enhanced transactions costs appear to counterbalance the gains from leveraged trading. In addition, when large price movements take place, the stock futures appear to play a much more important role. These findings help fill out our understanding of the role of the equity spot and single stock futures markets in price discovery.

Key words:price discovery, single stock futures, leverage trading, liquidity effects

JEL Code(s):G12, G14

Weblink: http://www.igidr.ac.in/pdf/publication/WP-2011-016.pdf