Lead-Lag Relationship in Spot and Future Market: Evidence from Pakistani Stock Market KSE-100 Index
Business Review, Vol 8: No 1. pp. 135-148, January-June 2013
14 Pages Posted: 6 Apr 2014
Date Written: 2013
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 indices were developed from the closing prices through the Price-Weighted index method. First stationarity of the data was checked through Augmented-Dicky Fuller test; then GARCH (1,1) model was estimated for both the spot and future index returns in order to investigate the volatility in either of the index. The results of GARCH (1, 1) suggest 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 role 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 is concluded based on the GARCH (1,1) there exists lead-lag relationship between the future and spot index where future market leads the spot market. Granger casualty test has been 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 in 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 is created about the security prices and then it disseminates to the spot market.
Keywords: Spot index, Future Index, Lead-Lag relationship, Granger Casualty, GARCH, Volatility
JEL Classification: C22, G10, G13, G15
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