Unified tests of causality and cost of carry: the pricing of the French stock index futures contract

Abstract

It is generally believed that the existence of Granger causality between stock index futures prices and spot prices is inconsistent with the cost of carry theory. In this paper, we argue that the logical links between Granger causality and cost of carry have not previously been correctly set out. We show that causality tests must be set in the framework of an error correction model (ECM) and that this is also the appropriate framework within which to test cost of carry theory. We, therefore, use a single unified framework to test both causality and cost of carry. Within this framework, we show that, under reasonable assumptions, cost of carry requires that there must be some causal relationships between futures and spot prices, and that cost of carry may be consistent with either bi‐ or unidirectional causality. We use our specification to study the pricing of the French CAC‐40 (CAC: Compagnie des Agents de Change) stock index futures contract. We find that the data are consistent with cost of carry only in the first period of the data, when causality only runs from spot to futures but not later, when causality is either bidirectional or runs from futures to spot. These results provide little support for the view that stock index futures necessarily lead spot and suggest the need for a reconsideration of the theory and evidence on stock index futures pricing. Copyright © 2000 John Wiley & Sons, Ltd.

Asymmetries, causality and correlation between FTSE100 spot and futures: A DCC-TGARCH-M analysis

“…Such methods create an artificial time series that ignores the cost of shifting between contracts because of movements in the basis, and we therefore do not adopt this approach. Instead, we followed Green and Joujon (2000) in utilising real transactions prices and defining a set of time-related variables to model the rollover jumps. See Section 4 below.…”

“…When contracts are spliced together in a single time-series, we get the familiar "sawtooth" pattern in the basis, with a jump each time a new contract enters the data. Following Green and Joujon (2000), we model the deterministic component of these movements by introducing a set of dummy variables.…”

“…The use of a VECM in this context is standard (for example, Wahab & Lashgari, 1993). However, we depart from the usual VECM by formulating the model so as to allow for the periodic jumps in the basis at contract expiration without the need to use an arbitrary rollover formula (following Green & Joujon, 2000). We use the estimated VECM to verify formally the validity of the sample split and test the residuals for ARCH.…”

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

“…As most futures contracts are heavily traded only in the last 3 months before delivery, data for the last 3 months of each contract were linked through time to create a single futures price history. Because mispricing can generate arbitrage at any time in the life of a contract, it would seem arbitrary to use data that switch to a new contract before expiration (Green and Joujon, ). We spliced data from successive contracts by shifting to the next near contract on each expiration day.…”

“…This creates an artificial time series that does not necessarily offer prices at which trades could be made or settled, and we therefore do not adopt this approach. Instead, to account for the rollover jumps while maintaining real transaction prices, we followed Green and Joujon (), defining dummy variables to model the rollover jumps (Section 4 below). Spot and futures prices are shown in Figure .…”