Does Stock Futures Market Drive the Stock Market or Does Stock Market React Independently?

By

Table of Contents

CHAPTER 1: INTRODUCTION3

1.1 Purpose of the Research3

1.2 Research Background4

1.3 Problem Statement6

1.4 Research Questions/Hypotheses7

CHAPTER 2: LITERATURE REVIEW9

2.1 Background of the functioning of Stock Markets9

2.2 Volatility of Stock Returns9

2.3 Traditional Financial Theory11

2.4 Various aspects of Stock Returns and Stock Market12

2.5 The Effect of Macroeconomic factors on Stock Market14

2.6 Common Trends of Stock Returns in the Stock Market14

2.7 Description of the Efficient Market Hypothesis16

2.8 Efficient Market Hypothesis17

2.9 Studies of the Weak Form of the Efficient market Hypothesis19

2.11 Trend Analysis25

Chapter 3: Methodology30

3.1 Research Approach and Design30

3.2 GARCH Statistical Technique and Model30

3.3 Sample Selection34

CHAPTER 4: DATA FINDINGS AND ANALYSIS35

4.1 Descriptive Statistics35

4.2 Empirical Results36

4.3 Discussions39

CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS44

REFERENCES46

CHAPTER 1: INTRODUCTION

1.1 Purpose of the Research

The purpose of this research is to examine the relationship between the stock future market and stock markets by emphasizing on the question that does stock futures market drive the stock market or does stock market react independently. In this regard, the paper would examine the relationship of stock future market via FTSE-100 Stock Index Futures and underlying FTSE-100 stock market. The research would examine whether FTSE-100 Stock Index Futures impact of trading on underlying stock markets of FTSE-100 and investigates that whether there is volatility in the underlying stock influenced by the FTSE-100 Stock Index Futures and whether the underlying FTSE-100 stock market reacts independently.

In order to examine the relationship between FTSE-100 Stock Index Futures as the means of “information” and the underlying stock markets as the means of volatility, the current investigation has employed the GARCH statistical family of techniques. The available literature indicated that the subject of future information index and stock volatility is not explored much within the context of United Kingdom (Aggarwal, 1988) and consequently, the researchers in the past did not give much attention to the relationship between FTSE-100 Stock Index Futures and underlying stock market of London Stock Exchange (Butterworth, 2000).

Considering the above facts, the current investigation attempts to empirically investigate whether stock futures market drive the stock market or does stock market react independently within the context of FTSE-100 Stock Index Futures and underlying stock market of London Stock Exchange. To examine this relationship, the first chapter of this dissertation is divided into three sections including background of the research, problem statement and finally the research questions.

1.2 Research Background

The volatility in the stock markets and the way it is impacted is largely associated with the stock future markets and their relative indexes (Antoniou, Koutmos & Pericli, 2005). Researchers such as (McKenzie, Brailsford & Faff, 2001) examined that ever since the notion of future trading started in 1865 in Chicago Board of Trade, there has been increasing concern about the relationship of future stock market indexes and stock markets and how future stock market impact the underlying spot markets. (Aggarwal, 1988) examined that the underlying assumption behind the significant relationship between two could be traced from the belief existing among the various market participants that stock market prices ...