Futures Versus Stocks: A Stochastic Dominance Study in Malaysian Markets

Abstract

This paper applies stochastic dominance (SD) tests to examine the dominance relationship between the futures and spot markets in Malaysia, the preferences for the risk-averse and risk-seekers in these markets, the existence of arbitrage opportunities, and whether the markets are efficient and rational. Our results show that there is no arbitrage opportunity in the Malaysian markets and that the Malaysian stock and futures markets can be considered efficient and rational. We find that the spot dominates the futures market on the downside risk, whereas futures dominate spot on the upside profits. In addition, we find that for the risk-averse, spot dominates futures under second-order SD (SSD), while for risk-seekers, futures dominate spot under SSD. This implies that the risk-averse prefer to buy indexed stocks, while risk-seekers are attracted to long index futures to maximize their expected utilities, but not their wealth. Based on our findings, the SSD relationship becomes stronger in the post-Mahathir sub-period.