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Illiquidity transmission from spot to futures markets

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  • Olaf Korn
  • Paolo Krischak
  • Erik Theissen

Abstract

We develop a model of illiquidity transmission from spot to futures markets that formalizes the derivative hedge theory of Cho and Engle (1999). The model shows that spot market illiquidity does not translate one to one to the futures market but, rather, interacts with price risk, liquidity risk, and the risk aversion of the market maker. The model's predictions are tested empirically with data from the stock market and markets for single‐stock futures and index futures. The results support our model and show that the derivative hedge theory provides an explanation for the liquidity link between spot and futures markets.

Suggested Citation

  • Olaf Korn & Paolo Krischak & Erik Theissen, 2019. "Illiquidity transmission from spot to futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(10), pages 1228-1249, October.
    • Handle: RePEc:wly:jfutmk:v:39:y:2019:i:10:p:1228-1249
    DOI: 10.1002/fut.22043
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    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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