An Application of Threshold Cointegration to Taiwan Stock Index Futures and Spot Markets

Ching-Chung Lin (), Shen-Yuan Chen () and Dar-Yeh Hwang ()
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Ching-Chung Lin: Department of Business Administration, National Cheng Kung University and Kao-Yuan Institute of Technology, No. 1821, Chungshan Rd., Luchu, Kaohsiung, 84141 Taiwan, ROC
Shen-Yuan Chen: Department of Finance, National Taipei College of Business, No. 321, Sec. 1, Chi-Nan Road, Taipei, 100 Taiwan, ROC
Dar-Yeh Hwang: Department of Finance, National Taiwan University, No. 50 Lane 144, Keelung Rd., Sec. 4, Taipei, 106 Taiwan, ROC

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2003, vol. 06, issue 03, 291-304

Abstract: This paper examines the arbitrage opportunity existing between Taiwan stock index futures and spot markets with the consideration of transaction costs. Index-futures arbitrageurs only enter into the market if the deviation from the equilibrium relationship is sufficiently large to compensate for transaction costs, as well as risk and price premiums. Employing the 5-minute intraday data of Taiwan index futures contracts, this paper uses the threshold cointegration model to estimate the upper and lower thresholds within which arbitrage is not profitable and, hence, the mispricing errors do not adjust back to equilibrium in the central regime. Combining these thresholds with an error correction model (ECM), empirical results show that there exists bi-directional Granger–causality relationship between index futures and spot markets. However, once the long-run cointegrated equilibrium does not hold, re-establishment of the equilibrium situation mostly depends on price adjustment in the futures market.

Keywords: Threshold cointegration; index futures; pricing; Taiwan (search for similar items in EconPapers)
JEL-codes: G1 G2 G3 (search for similar items in EconPapers)
Date: 2003
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Citations: View citations in EconPapers (3)

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DOI: 10.1142/S0219091503001109

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