Transactions Costs, Index Arbitrage and Non‐linear Dynamics Between Ftse100 Spot and Futures: A Threshold Cointegration Analysis

Abstract

We apply threshold cointegration to study the dynamics between the London FTSE100 spot index and its futures price, using percentage mispricing as the threshold variable to identify the no-arbitrage band. Estimated asymmetries in the band suggest that short sale restrictions in the spot market represent a hurdle for arbitrage. Factors other than transactions costs did not affect the width of the no-arbitrage band but did affect the price dynamics more directly. The evidence supports a conclusion that LSE SETS (1997) and LIFFE CONNECT (1998) trading systems reduced transactions costs and hence the width of the no-arbitrage band.

Determinants of Nikkei futures mispricing in international markets: Dividend clustering, currency risk, and transaction costs

“…Third, the exponential smooth transition autoregressive (ESTAR)‐GARCH model is used to examine the effects of transaction costs and heterogeneous investors on the nonlinear adjustments of Nikkei mispricing. ESTAR‐GARCH is arguably more satisfactory in describing these nonlinear adjustments than are threshold cointegration models (e.g., Tao & Green, ), as the former avoids the imposition of potentially arbitrary discontinuities on the aggregate arbitrage process. Recent studies using smooth transition include the Dow Jones (Tse, ), FTSE 100 (McMillan & Speight, ), S&P 500 (Taylor, ), Hang Seng (Fung & Yu, ), and emerging index futures (Sila Alan, Karagozoglu, & Korkmaz, ).…”

“…Third, the exponential smooth transition autoregressive (ESTAR)-GARCH model is used to examine the effects of transaction costs and heterogeneous investors on the nonlinear adjustments of Nikkei mispricing. ESTAR-GARCH is arguably more satisfactory in describing these nonlinear adjustments than are threshold cointegration models (e.g., Tao & Green, 2013), as the former avoids the imposition of potentially arbitrary discontinuities on the aggregate arbitrage process. Recent studies using smooth transition include the Dow However, to our knowledge, the ESTAR-GARCH model has not been applied to any of the three Nikkei markets, despite the fact that Nikkei futures contracts are one of the most actively traded derivatives in the world.The rest of this paper is structured as follows.…”

Nonlinear limits to arbitrage

“…2 As a robustness check, we provide the estimation results over a shorter sample (1990-2015) and results employing other S&P 500 futures contracts (e.g., 6 and 9 months to maturity), which are elaborated in the appendix. 3 In the extent literature with empirical applications using the error correction model (e.g., Balke & Fomby, 1997;Dwyer et al, 1996;Gyntelberg et al, 2017;Martens et al, 1998;Tao & Green, 2013;Theissen, 2012;Tse, 2001), past mispricing is often treated as an exogenous state variable that determines the arbitrage activity.…”