Information, Price Discovery and Causality in the Indian Stock Index Futures Market

This study examines the price discovery process and lead-lag relationship between NSE S&P CNX Nifty stock index futures and its underlying spot index, using daily data from January 1, 2004 to December 31, 2008. It investigates the long-term and short-term dynamics of prices between spot and futures market, using Johansen-Juselius cointegration test, Vector Error Correction Model (VECM), impulse response functions, and variance decomposition. In addition to it, the recently developed Granger non-causality tests of Toda and Yamamoto (1995) and Dolado and Lutkepohl (1996) have also been applied to examine the causal relationship between spot and futures markets. The obtained results support the existence of a long-run relationship between spot and futures prices. Further, VECM indicates short-run unidirectional causality from futures to spot market. In addition, the study finds unidirectional Granger causality from futures market to spot market through Toda-Yamamoto-Dolado-Lutkepohl (TYDL) causality test. The shape of the impulse response graphs shows that spot market has a larger response to shocks in the futures index than the futures responses to spot innovations. The results of variance decomposition indicate that the futures market shocks dominate over spot market in explaining the variation in spot market. However, disturbance originating from spot market contributes very less percentage variability to futures market. To conclude, futures price leads spot price and performs the price discovery function. The obtained results have important implications for traders, regulatory bodies and practitioners.