Abstract
The main objective of the study is to examine the long-term relationship between spot prices and futures prices A. The study has used daily prices (closing, opening, high and low) in both spot market and futures market for the 40 sample individual stocks drawn from six leading sectors namely, Automobiles, Banking, Cement, Gas, Oil & Refineries, Information Technology and Pharmaceutical. The period of study is from 1st January 1997 to 31st May 2009. The study begins by testing the stationarity of the spot price series and futures price series using two econometric methods namely, Philips Perron (PP) test and Augmented Dickey-Fuller (ADF) test. The long term relationship between spot prices and futures prices is statistically tested using Johansen’s test of Cointegration employing likelihood Ratio (L.R.), under the hypothesis that there exists a single cointegration equation between spot and future prices. It is found that both spot prices and futures prices for the selected companies are not stationary in the level form, but there is evidence of stationarity in the first difference form. The study finds a single long-term relationship for each of the selected companies across the six sectors. Among the selected companies in each sector, those evidencing strongest relation in respective sector are Tata Motors, Punjab National Bank, Gujrat Ambuja Cements, Bongaigaon Refineries, I-Flex and GLAXO Pharma.
Highlights
The Indian capital market has witnessed a major transformation and structural change from the past one decade as a result of ongoing financial sector reforms initiated by the Government of India
It is observed that the spot prices and futures of all the companies excluding Bajaj Auto are not significant in the level form with respect to Augmented Dickey-Fuller (ADF) test
It can be seen that the first differences in both spot and futures prices are observed to be stationary with significance at 1% level, and this is for both ADF and Philips Perron (PP) tests
Summary
The Indian capital market has witnessed a major transformation and structural change from the past one decade as a result of ongoing financial sector reforms initiated by the Government of India. One of the major objectives of these reforms was to bring the Indian capital market up to a certain international standard. Equity derivatives in India were started as a part of capital market reforms to hedge price risk resulted from greater financial integration between nations in the 1990s. These reforms were an integral part of financial sector reforms recommended by the Narasimham Committee Report on Financial System in September 1992. The reforms were aimed at enhancing, competition, transparency, and efficiency in the Indian financial market
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