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An Application of Threshold Cointegration to Taiwan Stock Index Futures and Spot Markets

Author

Listed:
  • Ching-Chung Lin

    (Department of Business Administration, National Cheng Kung University and Kao-Yuan Institute of Technology, No. 1821, Chungshan Rd., Luchu, Kaohsiung, 84141 Taiwan, ROC)

  • Shen-Yuan Chen

    (Department of Finance, National Taipei College of Business, No. 321, Sec. 1, Chi-Nan Road, Taipei, 100 Taiwan, ROC)

  • Dar-Yeh Hwang

    (Department of Finance, National Taiwan University, No. 50 Lane 144, Keelung Rd., Sec. 4, Taipei, 106 Taiwan, ROC)

Abstract

This paper examines the arbitrage opportunity existing between Taiwan stock index futures and spot markets with the consideration of transaction costs. Index-futures arbitrageurs only enter into the market if the deviation from the equilibrium relationship is sufficiently large to compensate for transaction costs, as well as risk and price premiums. Employing the 5-minute intraday data of Taiwan index futures contracts, this paper uses the threshold cointegration model to estimate the upper and lower thresholds within which arbitrage is not profitable and, hence, the mispricing errors do not adjust back to equilibrium in the central regime. Combining these thresholds with an error correction model (ECM), empirical results show that there exists bi-directional Granger–causality relationship between index futures and spot markets. However, once the long-run cointegrated equilibrium does not hold, re-establishment of the equilibrium situation mostly depends on price adjustment in the futures market.

Suggested Citation

  • Ching-Chung Lin & Shen-Yuan Chen & Dar-Yeh Hwang, 2003. "An Application of Threshold Cointegration to Taiwan Stock Index Futures and Spot Markets," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 6(03), pages 291-304.
    • Handle: RePEc:wsi:rpbfmp:v:06:y:2003:i:03:n:s0219091503001109
    DOI: 10.1142/S0219091503001109
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    Citations

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    Cited by:

    1. Jungshik Hur & Vivek Singh, 2013. "Does long-term disequilibrium in stock price predict future returns?," Review of Quantitative Finance and Accounting, Springer, vol. 41(4), pages 753-767, November.
    2. Gurmeet Singh, 2017. "Estimating Optimal Hedge Ratio and Hedging Effectiveness in the NSE Index Futures," Jindal Journal of Business Research, , vol. 6(2), pages 108-131, December.

    More about this item

    Keywords

    Threshold cointegration; index futures; pricing; Taiwan;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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