Impact of Index Futures on the Index Spot Market: The Indian Evidence

Abstract

The study is an empirical work conducted to assess the impact of trading of index futures on the returns and volatility of the index by examining the nature and strength of relationship that exists between Nifty Index and Nifty futures. The test statistics decisively accept the null hypothesis of equal returns, providing strong evidence of the inter linkages between two markets for CNX Nifty. Nifty Futures exhibit slightly higher volatility. The contemporaneous correlation of 0.9413 of Nifty and its futures suggests that the two time series are highly correlated. The lagged futures returns have forecasting power in explaining current spot index returns as the lag one coefficient is 0.1103. The subsequent lead/lag coefficients are diminishing and the results suggest that the cross correlation coefficients at longer leads/lags are not significant. The cross correlation coefficients indicate that the current spot returns are correlated to the current future returns and one-lead/lag futures returns. Futures thus lead the Index by one lead/lag in Nifty market. Granger Causality shows that returns on Nifty Futures cause returns on Nifty Index while the reverse is not true. Regressions run using GARCH (1,1) Model show that the interrelationships between the two markets are strong. There exists both the ARCH Effect (due to recent news) and GARCH effect (due to old news). GARCH effects are stronger in spot index markets for Nifty. ARCH effects are stronger in Index futures market. This implies that futures absorb recent information whereas index markets absorb old information. Thus, empirically it may be concluded that there is a bi-directional flow of information from futures market to the index market and vice versa.