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2013•Business ReviewOpen access

Lead-lag relationship in spot and future market: Evidence from Pakistani Stock Market KSE-100 Index

Hamid Ullah, Attaullah Shah

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Abstract

This paper has investigated the Efficient Market Hypothesis (EMH) through the concept of lead-lag relationship of the future market prices and spot market prices in the context of Pakistani stock market. The study has used data of randomly selected one hundred and forty firms listed on the Karachi stock exchange from January 1995 to March 2012. Spot and future indexes have been developed from the closing prices through the Price-Weighted index method. First stationarity of the data has been checked through AugmentedDicky Fuller test then GARCH (1,1) model has estimated for both the spot and future index returns in order to investigates the volatility in either of the index. The results of GARCH (1, 1) suggested that the impact of the previous day volatility in both the spot and future index has impact on the current day volatility. The future market price volatility has more prominent value to explain the spot market prices as compared to that of the explanatory power of the future market prices based on the spot market prices. Therefore it has concluded based on the GARCH (1,1) there exists lead-lag relationship between the future and spot index and future market leads the spot market. Granger casualty test has used to triangulate the results of GARCH (1,1) model. The results showed that future market Granger causes the spot market while the spot market does not Granger causes the future market. Thus it can be concluded that it is the future market prices that lead the spot market prices and thus there exist a Lead-Lag relationship between the future and spot market prices in Karachi stock exchange and one can predict changes spot market price based on the changes in the future market price. Moreover, these empirical results support the view that it’s the future market where information has created about the security prices and then it disseminate to the spot market. This study shall help the investors in the establishment of the investments strategies for Pakistani stock markets.

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What this paper is about

This paper has investigated the Efficient Market Hypothesis (EMH) through the concept of lead-lag relationship of the future market prices and spot market prices in the context of Pakistani stock market. The study has used data of randomly selected one hundred and forty firms listed on the Karachi stock exchange from January 1995 to March 2012. Spot and future indexes have been developed from the closing prices through the Price-Weighted index method. First stationarity of the data has been checked through AugmentedDicky Fuller test then GARCH (1,1) model has estimated for both the spot and future index returns in order to investigates the volatility in either of the index. The results of GARCH (1, 1) suggested that the impact of the previous day volatility in both the spot and future index has impact on the current day volatility. The future market price volatility has more prominent value to explain the spot market prices as compared to that of the explanatory power of the future market prices based on the spot market prices. Therefore it has concluded based on the GARCH (1,1) there exists lead-lag relationship between the future and spot index and future market leads the spot market. Granger casualty test has used to triangulate the results of GARCH (1,1) model. The results showed that future market Granger causes the spot market while the spot market does not Granger causes the future market. Thus it can be concluded that it is the future market prices that lead the spot market prices and thus there exist a Lead-Lag relationship between the future and spot market prices in Karachi stock exchange and one can predict changes spot market price based on the changes in the future market price. Moreover, these empirical results support the view that it’s the future market where information has created about the security prices and then it disseminate to the spot market. This study shall help the investors in the establishment of the investments strategies for Pakistani stock markets.

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Available abstract

This paper has investigated the Efficient Market Hypothesis (EMH) through the concept of lead-lag relationship of the future market prices and spot market prices in the context of Pakistani stock market. The study has used data of randomly selected one hundred and forty firms listed on the Karachi stock exchange from January 1995 to March 2012. Spot and future indexes have been developed from the closing prices through the Price-Weighted index method. First stationarity of the data has been checked through AugmentedDicky Fuller test then GARCH (1,1) model has estimated for both the spot and future index returns in order to investigates the volatility in either of the index. The results of GARCH (1, 1) suggested that the impact of the previous day volatility in both the spot and future index has impact on the current day volatility. The future market price volatility has more prominent value to explain the spot market prices as compared to that of the explanatory power of the future market prices based on the spot market prices. Therefore it has concluded based on the GARCH (1,1) there exists lead-lag relationship between the future and spot index and future market leads the spot market. Granger casualty test has used to triangulate the results of GARCH (1,1) model. The results showed that future market Granger causes the spot market while the spot market does not Granger causes the future market. Thus it can be concluded that it is the future market prices that lead the spot market prices and thus there exist a Lead-Lag relationship between the future and spot market prices in Karachi stock exchange and one can predict changes spot market price based on the changes in the future market price. Moreover, these empirical results support the view that it’s the future market where information has created about the security prices and then it disseminate to the spot market. This study shall help the investors in the establishment of the investments strategies for Pakistani stock markets.

Key concepts: Spot market, Autoregressive conditional heteroskedasticity, Volatility (finance), Stock market, Economics, Spot contract, Stock market index, Financial economics

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Lead-lag relationship in spot and future market: Evidence from Pakistani Stock Market KSE-100 Index — Research Paper | ScholarLens