The day the index rose 11 %: a clinical study on price discovery reversal

Christoph Schmidhammer (), Sebastian Lobe () and Klaus Röder ()

Review of Quantitative Finance and Accounting, 2016, vol. 46, issue 1, 79-106

Abstract: On October 28, 2008, Germany’s leading equity index Deutscher Aktienindex (DAX) rose 11.28 % which is the highest daily performance since its inception. That day, the arbitrage relationship between the cash and the futures market broke down. Based on this clean natural experiment, we examine price innovation dynamics of DAX related spot products for the days surrounding the event day. We find that price discovery is strongly reversed during the extreme event day with futures losing their common leadership to less liquid index certificates of market leading issuers. Evidently, strategic quote setting of certificate issuers drives the negative futures spot basis. An important broader implication from our research is that such an event is not unlikely to reoccur in the future. Although the Deutsche Börse AG calculating the DAX has reconsidered its rules since then, 30 out of 49 leading indices around the world do not include a relative weight cap. When the number of included firms is additionally low, the odds of another “Volkswagen event” increase. 14 out of the 30 uncapped indices include less than 50 firms. Copyright Springer Science+Business Media New York 2016

Keywords: Price discovery; Exchange traded funds; Index certificates; Index futures; G14; G13; C32; D4 (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1007/s11156-014-0462-4

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