Can we explain the dynamics of the UK FTSE 100 stock and stock index futures markets?

Chris Brooks, Ian Garrett
2002 Applied Financial Economics  
If stock and stock index futures markets are functioning properly price movements in these markets should best be described by a first order vector error correction model with the error correction term being the price differential between the two markets (the basis). Recent evidence suggests that there are more dynamics present than should be in effectively functioning markets. Using self-exciting threshold autoregressive (SETAR) models we analyse whether such dynamics can be related to
more » ... t regimes within which the basis can fluctuate in a predictable manner without triggering arbitrage. Our findings reveal that the basis shows strong evidence of autoregressive behaviour when its value is between the two thresholds but that the extra dynamics disappear once the basis moves above the upper threshold and their persistence is reduced, although not eradicated, once the basis moves below the lower threshold. This suggests that once nonlinearity associated with transactions costs is accounted for, stock and stock index futures markets function more effectively than is suggested by linear models of the pricing relationship.
doi:10.1080/09603100110087996 fatcat:elnhahfmlzbu7kvybiinnprmkq