The Pricing Behaviors of Stock Index Futures: Some Preliminary Evidence in the Korean Market

This research examines the pricing behaviors of futures contract in the Korean market in its early inception period. This research is mainly organized into three parts. The first chapter investigates the mispricing of futures contract relative to its theoretical value. Consistent with earlier studies regarding futures markets in other countries, futures have been persistently underpriced in the Korean market. Even after accounting for 10 minute execution lag in the arbitrage trading, arbitrage opportunities have been largely unexploited. Market inertia caused by institutional investors\u27 unfamiliarity is presumed to be largely responsible for underpricing of futures. Unfavorable spot market condition also hinders institutional investors from correcting for mispricing by arbitrage transactions. In the second chapter, lead and lag relationship in returns and volatilities between cash and futures markets is investigated. Based upon the Granger causality test, it is found that futures returns tend to strongly lead spot returns over the whole sample period although there is evidence that spot market also leads futures market from time to time. On the other hand, bi-directional causalities in volatility are observed between cash and futures market with strong ARCH and volume effects. In the final chapter, intraday volatility patterns in the Korean market are examined. In addition, volatilities between cash and futures markets are compared using several methods over the sample period. Generally, futures tend to be more volatile than spot. Combined with results obtained in the second chapter, this fact suggests that futures reflect new information more rapidly occurring in the marketplace than spot as Ross (1989) proposes. Finally, the expiration day effect on the spot and futures market volatilities is also investigated. On average, spot market does not display any extreme volatility around the expiration date, but futures tend to be more tranquil as they approach maturity. Overall, the pricing behavior of index futures in the Korean market seems to have followed the same path as recorded in the futures markets of other countries