Price discovery on the S&P 500 index markets: an analysis of spot index, index futures, and SPDRs

Abstract

This paper investigates the price discovery function in three S&P 500 index markets the spot index, index futures, and S&P Depositary Receipts markets. Four hypotheses regarding market structure and security design are proposed to differentiate the price discovery function performed by the three index instruments Using matched synchronous intraday trading data, Johansen's maximum likelihood estimator is employed to disclose the cointegration relationships among the three markets. Results indicate that the three price series are a cointegrated system with one long-run stochastic trend. Estimated coefficients of the vector error correction model indicate that both spot index market and SPDRs defer to futures price for their own pricing. When the common stochastic trend is decomposed, it is found that the futures market serves the dominant price discovery function. The leverage hypothesis and the uptick rule hypothesis explain its superior price discovery function.