Informational Efficiency and Spurious Spillover Effects between Spot and Derivatives Markets

Abstract

Research on the relationship between spot and derivatives markets has attracted the interest of many economists and financial analysts. According to many researchers there exists a puzzle regarding the lead-lag effect and the causality of possible spillover effects between these markets. Derivatives markets should produce the means for price discovery with a leading role in the transmission of new information. Thus, the standalone examination of the relationship of the volatility between spot and derivatives markets, does not account for possible disequilibria in the long term relationship and the informational efficiency between these markets and result in spurious spillover effects, diminishing, thus, the importance of derivatives markets as being well functioning and efficient ones. This paper uses data from three European stock market indices and contributes to the literature on the spot-derivatives spillover effects by controlling for possible disturbances in the long run equilibrium relationship between them, through a regime shift econometric approach taking into account structural breaks which are statistically and economically important. The empirical findings of the paper are in favour of the informational efficiency of these markets only partially for specific sub-periods, for which the spillover effects as well as the price discovery inherent in derivatives markets are significant.