Price Discovery between Informationally Linked Markets During Different Trading Phases

Abstract

The dynamic nature of the price information transfer when stock and futures markets switch between different price trading phases is examined. This is undertaken by decomposing Australian stock indices and share price index futures contract data into bear and bull periods and analyzing the change in the power of the bi-directional information feedback between the futures market and small, medium and large stocks. Results support the hypothesis that the nature of the price discovery process varies with the trading phase. In particular, during the bull phase small stocks show a marked increase in price exogeneity and futures prices contain relatively less price sensitive fundamental information. We argue that in bull markets, futures trading becomes increasingly associated with non-information trading such as realizing paper profits, portfolio rebalancing and increased noise trading.

JEL Classification: G14