Effect of Market Imperfection on the Relationship between Future Index Prices and Spot Index Returns: An Empirical Study

[[abstract]]The degree of market imperfections affects the pricing of financial assets and the dynamic relationship among financial instruments. To investigate the dynamic interrelationship between the expected growth rate implied by the prices of index futures and the rate of return of the underlying index spot, this study examines data from the S&P 500, Nikkei 225 index futures and the TAIFEX TAIEX index futures by using the vector autoregression (VAR) model, Granger causality test, and generalized impulse response function (GIRF). The empirical result shows that the dynamic interrelationship is weaker in the mature US and Japanese markets (which represent a more perfect market) than in the emerging Taiwanese market (which represents an imperfect market). Examining the relationship between future index prices and spot index returns is an effective way of investigating market imperfections and inefficiencies