Temporal Causality between the Malaysian Stock Price and Stock‑indexed Futures Market amid the Selective Capital Controls Regime

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I. Introduction A voluminous number of causal studies on the stock market between spot and futures prices have been investigated. A cursory survey indicates that the major trend of empirical results for the causality relationship between the spot and futures markets tends to fall into three different categories, namely, (1) unidirectional causality, (2) bi-directional (or feedback) causality, and (3) no causal relationship between the variables. An early study by Lim (1992) found no evidence of cross correlation that futures prices led spot prices, or spot prices led futures prices in the Nikkei stock index futures market. On the other hand, Wahab and Lashgari (1993) who used the error correction model (ECM) on daily data for the SP which may result in spurious causality tests. It also allows for the measurement of structural break for the period studied, that is the period before and after the implementation of selective capital controls regime in Malaysia. In short, the paper analyses Granger causality between the stock market (composite) index and stock futures index of the Malaysian stock exchange and futures markets respectively, amid the implementation of the selective capital controls policy by the Malaysian Government. The standard Granger causality test using the F-statistics will be estimated for the basis of comparison with Hsiao's (1981) sequential approach and the error correction model (ECM). The study is organized as follows. Section I provides a brief introduction. Section II presents some characteristics of the Malaysian stock and futures markets. The research methodology is discussed in Section III. In this section, the first step is to test for stationarity of the time series; whether the stock market exhibits a random walk process. Cointegration test is performed to indicate support for the economic variables as a long-run condition, and finally, vector error correction models are used to test the cointegrated relationship for dynamic adjustment of stock prices in the short-run and long-run equilibrium. …