Lead – Lag Relationship between the Romanian Cash Market and Futures Market

The fundamental purpose of this paper is to unravel the way price discovery works in the Romanian markets and at the same time explain its most obvious mechanisms. This is an aid for traders that use both markets (cash and futures) but at the same time it is a relevant input when trying to assess local market and investor maturity. It may also be a relevant piece of information for market regulators, as it gives an inside into the way the whole stock market set works; the indicators analyzed are a result of all the elements interacting in the stock market, not only some. Price discovery mechanisms in the equity and futures markets yield important data for traders if uncovered. One important factor in price discovery is the exchange of information between the cash market and the futures market, when futures contracts with listed equities as underlying assets are traded. When new information emerges, it is integrated in the two markets with different speeds, depending upon the characteristics of the markets and the investors involved. Hence, a lead-lag relation between the two markets emerges. We try to discover and explain this relation using two different models, (and two implicitly different approaches: top-down and bottom-up). The data series used are high frequency observations of the instantaneous return rates for two listed market funds (SIF2 and SIF5) along with their futures contracts (DSIF2 and DSIF5); the traded volumes are also inputs. The results show that, in opposition to US markets results, the Romanian cash market leads the futures market by three to five minutes. The results generally hold strong under different conditions: long data series – short data series (top-down approach with 45.000 observations, bottom-up approach with 500 observations), higher frequency – lower frequency data (one minute – five minutes), high volume – low volume, good news – bad news and bull – bear market.