Interaction between Equity and Derivatives Markets in India: An Entropy Approach

Abstract

The temporal relationship between the equities market and the derivatives market segments of the stock market has been studied using various methods and by identifying lead-lag relationship between the value of a representative index of the equities market and the price of a corresponding index futures contract in the derivatives market. It has been generally observed that price innovations appear first in the derivatives market and are then transmitted to the equities market. In this paper, the dynamics of such information transport between stock market and derivatives market are studied using the information theoretic concept of entropy, which captures non-linear dynamic relationship also.