The trading dynamics of close-substitute futures markets: evidence of margin policy spillover effects

Abstract

Cross border volatility spillover effects between capital markets is a well-documented empirical phenomenon, especially among closely related securities. For the case of close-substitute markets, it is of interest to investigate the existence of other potential spillover effects. We examine the relationship between margin policy, price discovery and trading dynamics of the Nikkei 225 index futures contract that is cross-traded between the Osaka Securities Exchange and the Singapore Exchange, and find strong evidence of margin policy and trading volume spillover effects. We present two key sets of results: (i) The Osaka Securities Exchange, which adopts a more extreme margin policy. appears to influence the dynamics of trading across both futures markets, whereas the margin policy adopted by the Singapore Exchange appears to influence only its own trading volume. (i,) Consistent with prior studies, We find evidence that it is the less liquid offshore satellite market that takes on the price discovery role, even though the home market dominates in terms of trading volume. Despite the simplistic econometrics approach, the significant findings in this paper offer two interesting implications: (a) If margin requirements is perceived as a regulatory tool, then corresponding policy markers of close substitute markets have to coordinate, if not at least communicate their actions, due to the policy spillover effect. But if margin setting is to be perceived as a business tool. it raises the question as to whether a prior interaction is feasible, given that they are actually business rivals. (b) It is possible for two futures markets to co-exist in the same region if one supplies immediacy, whilst the other provides price discovery. The market design adopted by the Singapore Exchange appears to facilitate the latter. This would strongly suggest that a strategic framework of market design that is capable of overcoming "the winner takes all" syndrome is of paramount value to any modern futures exchange.