Information content, extended hours and the relationship between cash and index futures markets

Abstract

Starting from 20 November 1998, Hong Kong Futures Exchange (now named as Hong Kong Exchange) extends the trading hours of Hang Seng Index Futures contracts by opening 15 minutes earlier in the morning session, and closes 15 minutes later in the afternoon session. This thesis focuses on the two aspects in the index futures and the cash markets in Hong Kong after the extension of the trading hours. The first part of the thesis follows the model in the paper of Hiraki, Maberly and Takezawa (1995) and examines the information content of the index futures market during the extended trading hours and its effect to the underlying cash market trading period returns for the following day. Consistent with the findings of Hiraki, Maberly and Takezawa (1995), the extended index futures trading plays an important role for the price discovery process. In particular, the pre-opening futures returns have a predictive power over the cash market returns. In addition, the futures prices tend to reverse in the subsequent session which can be explained by the arguments of either the liquidity-driven trading at market close (Gushing and Madhavan (2000)) or overreaction (Fung, Mok and Lam (2000)). The second part of the thesis investigates the lead-lag inter-market relations between the two markets after the trading extension and sees if there is any significant change in the inter-market relation afterwards. The result shows that after the trading extension, the lead from the futures market returns to the cash market returns is significantly weakened during the first 15 minutes of trade in the cash market. This result indicates an enhancement in the efficiency of the opening price of the cash market after the trading hour extension in the futures market. After 30 minutes of trade, the lead from the futures market to the cash market becomes strengthened again, which indicates the effect of the trading extension is weakening. The strengthened lead from the futures market to the cash market may attribute by the random arrival of the new information to both markets during the trading session. In conclusion, the result of this study indicates that trading extension in the futures market enhances the price discovery process and the pricing efficiency in the cash market.