An Examination of Price Discovery and Hedging Efficiency of Indian Equity Futures Market

24 Pages Posted: 12 Feb 2007

See all articles by Kapil Gupta

Kapil Gupta

Guru Nanak Dev University

Balwinder Singh

Guru Nanak Dev University - Department of Commerce and Business Management

Abstract

Present study investigates the price discovery and hedging efficiency of NIFTY and all those stock futures whose trading started on 9th November 2001 and are continuously traded till 30th June 2006. The study observes information asymmetry in both futures and cash market and significant Jarque-Bera test rejects the hypothesis that returns in both markets follow normal distribution. Both futures and cash market returns are found to be integrated of order 1, which implies that strong long-run relationship exists between two markets and these results are strongly supported by predictable and stationary basis. Presence of information asymmetry and cointegration implies that both markets are inefficient in weak form. Moreover, Granger causality and Vector Autoregression (VAR) results provides significant evidence that futures market leads cash market, which implies that futures market is an efficient price discovery vehicle. On the basis of price discovery efficiency of the futures market, hedge ratio through EGARCH (1,1) and VAR (based on Error correction Methodology) have been estimated, which suggests that efficient price discovery of futures market provides good opportunities for the traders to hedge their market risk because hedging through futures (except for RELIANCE) help the traders to reduce portfolio variance by approximately 90% and even more in some cases.

Keywords: Information Asymmetry, Cost-of Carry, Price Discovery, Basis Risk, Hedge Ratio and ARCH Effect.

Suggested Citation

Gupta, Kapil and Singh, Balwinder, An Examination of Price Discovery and Hedging Efficiency of Indian Equity Futures Market. 10th Indian Institute of Capital Markets Conference Paper. Available at SSRN: https://ssrn.com/abstract=962002 or http://dx.doi.org/10.2139/ssrn.962002

Kapil Gupta (Contact Author)

Guru Nanak Dev University ( email )

Amritsar, Punjab 143005
India

Balwinder Singh

Guru Nanak Dev University - Department of Commerce and Business Management ( email )

Department of Commerce and Business Management
Guru Nanak Dev University
Amritsar, Punjab 143005
India
09417272232 (Phone)
0183-2255564 (Fax)

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