Cointegration, Error Correction, and Price Discovery on Informationally Linked Security Markets

JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS

Posted: 23 Aug 1998  

Frederick H. deB. Harris

Wake Forest University; Capital Markets CRC Limited (CMCRC)

Thomas H. McInish

University of Memphis - Fogelman College of Business and Economics

Gary Shoesmith

Wake Forest University - School of Business

Robert Wood

University of Memphis - Fogelman College of Business and Economics

Abstract

Using synchronous transactions data for IBM from the New York, Pacific and Midwest Stock Exchanges, we estimate an error correction model to investigate whether each of the exchanges is contributing to price discovery. Johansen's multi-variate cointegration test yields two cointegrating vectors which together verify the expected long-run equilibrium of equal prices across the three exchanges. Price discovery in our sense then refers to the adjustment process by which informationally linked security markets resolve price disparities after coincident but unequal price changes. Two error correction terms specified as the difference between IBM prices on the Pacific versus NYSE and on the Midwest versus NYSE indicate that adjustments maintaining the long-run cointegration equilibrium take place on all three exchanges. That is, IBM prices on the NYSE adjust toward IBM prices on the Midwest and Pacific Exchanges, just as Midwest and Pacific prices adjust to the NYSE. The findings are robust to several data collection procedures yielding different observation intervals, different orderings of the data tuples, and different time periods.

JEL Classification: G12

Suggested Citation

Harris, Frederick H. deB. and McInish, Thomas H. and Shoesmith, Gary and Wood, Robert, Cointegration, Error Correction, and Price Discovery on Informationally Linked Security Markets. JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS. Available at SSRN: https://ssrn.com/abstract=6319

Frederick (Rick) H. deB. Harris (Contact Author)

Wake Forest University ( email )

2601 Wake Forest Road
Babcock Graduate School of Management
Winston-Salem, NC 27109
United States
336-758-5112 (Phone)

Capital Markets CRC Limited (CMCRC) ( email )

Level 3, 55 Harrington Street
Sydney, 2000
Australia

Thomas H. McInish

University of Memphis - Fogelman College of Business and Economics ( email )

Memphis, TN 38152
United States
901-678-4662 (Phone)
901-678-3006 (Fax)

Gary Shoesmith

Wake Forest University - School of Business ( email )

P.O. Box 7659
Winston-Salem, NC 27109-7285
United States
336-758-5053 (Phone)
336-758-4514 (Fax)

HOME PAGE: http://business.wfu.edu/directory/gary-l-shoesmith/

Robert A. Wood

University of Memphis - Fogelman College of Business and Economics ( email )

Memphis, TN 38152
United States
901-678-2670 (Phone)
901-678-3006 (Fax)

HOME PAGE: http://www.people.memphis.edu/~rwood/

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