The stock markets in mainland China have achieved rapid development and recently became the second largest, following the US stock markets in terms of the market capitalization. However, the country’s derivative markets are still in their infancy. In April 2010, the China Financial Futures Exchange (CFFEX) launched the CSI 300 Index futures, the first stock index futures in mainland China. In early 2015, the Shanghai Stock Exchange (SSE) and the CFFEX launched the first exchange traded fund (ETF) options (SSE 50 ETF options) and the second index futures (SSE 50 Index futures).
The introduction of futures and options virtually enables short-selling and adopts the “T+1” settlement system and market making system. These aspects are conducive to enhancing market quality. Previous studies have documented the price discovery role between a single derivative market (either futures or options) and its underlying spot market (an index or its tracker fund). However, relatively few papers have considered the spot, futures and options markets jointly, particularly in emerging countries. If both futures and options are actively traded but one only considers a bivariate relationship between a single derivative market and its underlying spot market, then the estimated contribution to price discovery can be biased because of the omitted variable.
PHBS Assistant Professor Sungbin Sohn and his coauthors paper Price Discovery among SSE 50 Index Based Spot, Futures, and Options Markets estimates the relative contribution to price discovery in the spot, futures, and options markets without potential bias by analyzing the three co integrated markets jointly. The paper was accepted and published by The Journal of Futures Markets, an internationally renowned financial journal, in collaboration with Dr. Kwangwon Ahn of Korea Advanced Institute of Science and Technology, and Bi Yingyao of China Merchants Securities.
Compared to data used in previous studies, the sample in this paper is particularly interesting and valuable, as the Chinese derivatives markets underwent dramatic up and down swings and abrupt regulatory changes during the sample period. The literature has shown significant evidence that supports the trading cost hypothesis: the dominant price discovery role in the derivatives markets is attributed to their relatively lower transaction cost. This sample period enables us to test this hypothesis because substantial and almost exogenous changes in the transaction cost occurred within several years.
Following Hasbrouck (1995)’s information shares (ISs) model, the authors find that although the Chinese derivatives markets have only several years of trading history, they quickly began exhibiting price leadership over the spot market. Moreover, the results show that bivariate analysis that considers only futures or options market overestimates the contribution of the derivative market to price discovery, which confirms the importance of analyzing spot, futures and options markets jointly.
Finally, this paper explores factors that affect the time variation in price discovery of the derivatives. The results show that in the options market, the price discovery role is positively correlated with trading volume and negatively correlated with return volatility, which is consistent with the literature. In other words, more trading activities and smaller uncertainty are conducive to better price discovery. In the futures market, however, the trading volume is not significantly associated with the strength of price discovery.
Even with more than a 90% plunge in trading volume after stringent regulations, the futures market still makes a considerable contribution to price discovery, and its IS, CFW, and net spillovers did not significantly decrease. Interestingly, in neither futures nor options markets, price discovery is significantly affected by relative transaction costs. This finding is not consistent with the trading cost hypothesis. The authors conjecture that in a nascent market, investors’ trading experience matters more for price discovery than the transaction cost. This could be the reason that the IS in the SSE 50 Index futures has been large since its introduction, while it took a long time for the SSE 50 ETF options to play a considerable price discovery role.
By Du Wenxin
Edited by Priscilla Young and Annie Jin
