Lead-Lag Relationship between Spot and Futures Stock Indexes: Intraday Data and Regime Switching Models

Abstract

This paper analyses the lead-lag relationship and the effect of arbitrage opportunity changes in the price discovery process between the futures and spot markets of the DAX30. The following two aspects will be considered: high frequency data and nonlinearities in the cointegrating vector. The results reveal the importance of considering structural changes present in the error correction term using Regime Switching Models and the peril of assuming strong linear models. Additionally, the regime dependent impulse response function shows that the dynamic causal effect is remarkably different across regimes, so as the arbitrage opportunities increase, the impact of unexpected shocks on prices increases.

Keywords: regime switching models, arbitrage opportunities, lead-lag relationship, intraday data

JEL Classification: G12, G14, G15, G13