Empirical Evidence of the Causative Association between Spot, Futures and Options Market: An ARDL Model Approach

Abstract

Purpose: The purpose of this paper is to explore and provide evidence about the nature of short run causal relationship as well as the speed with which prices adjust towards achieving the long run equilibrium between cash and FAO markets in India as represented by National Stock Exchange. The study uses individual stocks for studying the underlying relationship.

Design/Methodology: The paper makes use of the auto regressive distributed lag model to study the causal relationship between spot, futures and options markets. The study makes use of the 15-minute interval trades data for the purpose of analysis.

Findings: The ARDL model shows a long run association between spot, futures & options (both call & put) prices but we do not have sufficient statistical evidence to conclude the short run causal association between the variable except for call and put options.

Practical Implications: The results indicate that derivative markets are not leading the spot market but spot market contributes towards price discovery in the FAO markets. Potential investors can take their positions and design their portfolio in the cash and FAO segments using the insights provided by this piece of work.

Originality/Value: This paper is an original piece of work towards evidencing the causative association between spot, futures and options markets using individual securities. Matters pertaining to price discovery process in Indian financial markets are issues of interest for financial thinkers, traders, investors and financial analysts.