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Price discovery in equity markets: A state-dependent analysis of spot and futures markets

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  • Kuck, Konstantin
  • Schweikert, Karsten

Abstract

This paper investigates the potentially time-varying importance of spot and futures markets in the price discovery process of financial assets. For this purpose, we generalize the concept of component shares and information shares to allow for state-dependent relevance of different markets over time. Instead of using a linear vector error correction model (VECM) to construct the component shares and information shares as it is common in the literature, we employ a Markov-switching VECM with time-varying adjustment behaviour and state-dependent covariance matrices. Simulation results confirm that state-dependent component shares and information shares can be estimated consistently within this framework. We apply our approach to spot and futures prices for different stock indices such as EuroStoxx50, FTSE100, Nikkei225, and SP500. We find a clear state probability pattern over the trading day that closely resembles the well-studied volatility smile and might be related to the presence of heterogeneous agents in those markets.

Suggested Citation

  • Kuck, Konstantin & Schweikert, Karsten, 2023. "Price discovery in equity markets: A state-dependent analysis of spot and futures markets," Journal of Banking & Finance, Elsevier, vol. 149(C).
    • Handle: RePEc:eee:jbfina:v:149:y:2023:i:c:s037842662300033x
    DOI: 10.1016/j.jbankfin.2023.106808
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    More about this item

    Keywords

    Cointegration; High-frequency; Markov-switching; Volatility; Index price formation;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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