Abstract
The study is conducted to investigate the relationship of single stock futures with the spot price in Karachi Stock Exchange. Monthly data of twelve companies which are trading single stock futures have been examined for the period 1 January, 2005 to 31 December, 2010 with total of 72 observations for each company. Descriptive statistics, Unit Root test, Co-integration test, Granger Causality test, Vector Error Correction Model based on ARDL approach, Impulse Response and Variance Decomposition tests are used. The existence of long run relationship was found between the futures and spot prices of all the companies. The Granger Causality test reported that the spot prices of FFBL and LUCK assist in forecasting their respective futures prices. The futures prices of HUBC and POL forecast their respective spot prices and play its important role of price discovery. The impulse response analysis revealed that most of the shocks in the futures markets of all the selected companies are explained by their own innovations and their respective spot markets have less influence on them. Variance decomposition test reported that futures market is an exogenous market as majority of its stocks are explained by its own innovation. The results of VECM shows that in case of disequilibrium the adjustment process is quite fast for all the companie
Highlights
The impact of derivatives trading on the underlying assets has long been studied but still debatable
The study uses Descriptive Statistics, Unit Root Test, Vector Auto Regression (VAR Technique), Johansen and Juselius Co-integration Test, Granger Causality Test, Impulse Response Test, Variance Decomposition Test and Vector Error Correction Model to explore the relationship between the futures and spot market
The maximum eigenvalue statistics in table 5 reports one co-integration equation between the spot and futures prices of BOP, DGKC, FFBL, FFC, NML and PTC while two co-integration equation has been found between the spot and futures prices of ENGRO, HUBC, LUCK, OGDC, POL and PSO at 5% critical value
Summary
The impact of derivatives trading on the underlying assets has long been studied but still debatable. The derivatives provide information about futures prices of the underlying asset. The theoretical investigation into the effects of futures trading on the underlying spot market volatility reports inconclusive results. Subrahmanyam (1991) propose theoretical model to investigate the effect of index futures on the underlying spot market volatility and comes with ambiguous results. Chari and Jagnnahthan (1990) concluded that it is not possible to solve the issue of futures trading effect on underlying spot market volatility with theoretical models. These studies concluded that the spot market contributed 21% to price dicovery while for domestic and foreign futures market the figure was 46% and 33% respectively Several other studies such as Khan (2006), Ahmad, Shah and Shah ( 2010) and Chatrath et al, (1998) have investigated the role of future in price discovery. The emprical results in the literature are vaned with most of the studies with the consensus that futures play important role in price discovery
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