Contribution of Indian Index Futures to Price Formation in the Stock Market

In this paper we analyse whether the Indian Stock Index Futures market plays an important role in the assimilation of information and price discovery in the stock market. Using Futures prices for the S&P CNX Nifty Index traded on the National Stock Exchange of India, we find that there is significant information flow from the futures to the spot market and futures prices/returns have predictive power for the spot prices. If we take account of the long run relation between the two price series we find clear bidirectional information flows or feedback between the markets. The contributions of the two markets to the price discovery process are also almost equal with the futures showing a marginal edge over the spot market, as the information flow into the stock prices from the futures is slightly higher than the price information flows to the futures market from the spot market. The futures market also readjusts faster to market-wide information and thus absorbs much of the volatility induced by flow of new information.