Quentin C. Chu

Price discovery on the S&P 500 index markets: An analysis of spot index, index futures, and SPDRs

Abstract This paper investigates the price discovery function in three S&P 500 index markets: the spot index, index futures, and S&P Depositary Receipts markets. Four hypotheses regarding market structure and security design are proposed to differentiate the price discovery function performed by the three index instruments. Using matched synchronous intraday trading data, Johansens maximum likelihood estimator is employed to disclose the cointegration relationships among the three markets. Results indicate that the three price series are a cointegrated system with one long-run stochastic trend. Estimated coefficients of the vector error correction model suggest that price adjustment takes place in the spot index market and for SPDRs, but not in the futures market. When the common stochastic trend is decomposed, it is found that the futures market serves the dominant price discovery function. The leverage hypothesis and the uptick rule hypothesis explain its superior price discovery function.

Bid-Ask Bounce and Spreads in the Foreign Exchange Futures Market

This paper examines the intraday bid-ask bounce in Deutschemark and Japanese yen futures prices. The intraday Markovian bid-ask bounce process, which leads to a desirable equilibrium condition of reaching a bid or an ask transaction type with equal chances, is identified. A second-order Markov chain transition matrix model is used to derive a generalized estimator of bid-ask spreads in the foreign exchange futures market. It incorporates the conditional probabilities of a subsequent transaction being the same type as the current transactions (δ) and that of the next transaction being the same as the current type but different from the previous type (α). The specification is {-Cov(ΔPt,ΔPt+1)/[(1−δ)(−α)]}1/2. The empirical results show that the average implied bid-ask spread is about

When Do TIPS Prices Adjust to Inflation Information

10, which is less than one ticks value of

Inflation or disinflation? Evidence from maturing US Treasury Inflation-Protected Securities

12.50. It is also found that spreads are higher at the beginning and end of the trading day than the rest of the day, reflecting the uncertainty due to information flows and overnight inventory carrying costs, respectively.

Real rates, nominal rates, and the Fisherian link

This event study of market efficiency found that prices of Treasury Inflation-Protected Securities (TIPS) adjust to inflation information without delay during the U.S. Consumer Price Index (CPI) survey period and even before the beginning of the survey period. The cumulative effect of unexpected inflation on the TIPS holding period returns peaks at the end of the survey period. After the CPI announcement, there is no discernible price adjustment. A basic tenet of financial theory is that the market-determined price of a security that promises future cash flows should incorporate changes in inflation expectations over the life of the security. The degree of market efficiency in this regard, however, has been difficult to measure. Tests of how quickly new information about future inflation is incorporated into security prices have been complicated by the presence of many factors other than inflation that affect market prices on a daily basis. Moreover, demonstrating the efficiency of the response of security prices to inflation as it occurs and before its announcement has been difficult. Given the direct link between future cash flows and the ex post U.S. Consumer Price Index (CPI), Treasury Inflation-Protected Securities (TIPS) are uniquely structured to aggregate inflation information before the monthly public announcement. Because the cash flows associated with TIPS depend on actual inflation and a contractual real return, TIPS prices react far differently over time than do conventional bond prices, which respond to changes in the expected rate of inflation until maturity and in the expected real rate. Assuming contemporaneous adjustment of the contractual cash flow to the current CPI, TIPS prices respond to changes in actual inflation and in the expected real rate. Using pooled time-series, cross-sectional data from three recently matured TIPS issues, the authors investigated how quickly TIPS prices respond to the monthly update of the CPI. Their results suggest that TIPS prices efficiently aggregate near-term inflation information. The evidence supports a market that is highly informed about upcoming inflation starting 44 business days before the CPI announcement date. In fact, using the pooled data of all three issues, the authors found that 29 percent of the cumulative adjustment to information about the upcoming month’s inflation is already incorporated into the TIPS prices before the survey period begins. Moreover, the cumulative effect of unexpected inflation on TIPS returns peaks on the last day of the month as the sampling ends, with 98 percent of the inflation adjustment already in the TIPS prices. On the announcement date, the TIPS prices make the final adjustment to correct a reversing trend during the compilation period. The significant adjustment on the announcement date returns the cumulative effect to a level slightly higher than the level at the end of the month. Thus, the market is very efficient at monitoring and responding to changes in consumer prices. Using the monthly CPI survey published by the Blue Chip Financial Forecasts instead of the breakeven inflation rate to measure expected inflation, the authors found no significant difference in the timing of TIPS price adjustments. This finding suggests that the market-determined measure of expected inflation, even for securities with a five-year maturity, is robust in capturing near-term inflation surprises. To isolate the timing parameters of the TIPS price adjustments to inflation information, the authors used a regression model with three control variables based on TIPS trading and indexing characteristics. The three control variables contribute to an overall improvement in modeling TIPS holding period returns (HPRs). One important construct in the modeling of the TIPS HPR is an expected one-to-one response between the TIPS HPR and the total effect of inflation. The authors found that the hypothesis of a one-to-one relationship holds, and they demonstrated that TIPS prices move directly with past inflation (a proxy for “ongoing” inflation) and the arrival of new inflation information during the observation window. The authors’ results are consistent with profit-motivated inflation forecasting by economists and financial analysts that speeds up the TIPS price adjustment process.

Information Content of Maturing TIIS

The prices of maturing US Treasury Inflation-Protected Securities (TIPS) during the last 6-month coupon period reveal whether the market is anticipating an inflationary or disinflationary regime. Against the benchmark of the Treasury bill yield to adjust for the time value of money, maturing TIPS prices represent a sequence of updated forecasts of the consumer price index (CPI) to be used to determine the final single cash flow on the maturity date. Under the assumption of risk-neutrality, the sequence of forecasts is modelled as a martingale. Generalized method of moments and regression analysis are used to test two martingale properties of the CPI forecasts: (1) the unconditional mean of daily changes in the CPI forecasts is zero and (2) serial correlations of the daily changes in the CPI forecasts are zero. The test statistics reject both martingale properties of the CPI forecasts implied in maturing TIPS prices. A persistent upward movement of the CPI forecasts toward the actual target CPI during the first quarter of 2002 implies the market was then anticipating a disinflationary regime. One policy implication is that time series behaviour of CPI forecasts can provide timely feedback to the Federal Reserve Open Market Committee.

A Global Investigation of Dividend Yields: Shareholder Demand, Agency Problems, and Market Quality

Abstract Before the introduction of Treasury Inflation-Indexed Securities (TIIS) in January 1997, the ex ante real rate in the United States was unobservable. This study describes the new Treasury security and extracts from its price a time series of ex ante real pure discount rates with a constant 10-year maturity. The study then identifies an ex ante nominal rate time series counterpart. Empirical evidence from Johansens cointegration analysis indicates that there exists a cointegrated system between the real and nominal rates. This finding casts doubt on the accuracy of tests of the Fisher effect that infer a constant or stationary real rate.

The opening price behavior: Foreign exchange futures market versus equity market

During their last coupon period, Treasury Inflation-Indexed Securities (TIIS) are transformed from inflation-protection securities into Treasury bills due to the lag effect in indexing inflation. A study of the first issue of TIIS that matured on July 15, 2002, indicates that TIIS prices in the final six months convey useful information about the markets assessment of inflation risk. TIIS prices reveal that the market was concerned more about disinflation than inflation during the first quarter of 2002. This special period of transformation also permits a controlled experiment of the markets ability to aggregate information about inflation; TIIS prices efficiently reflect inflation information at the time inflation takes place.

Asymmetric return dynamics and technical trading strategies

We compare cross-sectional variation of dividend yields of companies across 32 countries. Beyond the impact of firm-specific accounting and financial variables, this study investigates how the variations in country level variables affect dividend payout policies. The country level variables include shareholder demand due to demographic variations and consumption needs, agency problems manifested in the extent of minority shareholder protection and business disclosures, and market quality in terms of transparency and liquidity. We find that dividend yields are higher when diverse shareholder demands are strong, extents of business disclosures and legal protections are weak, and the market qualities are poor. The empirical evidence supports the demand-based theory in a global setting and the essence of bird-in-the-hand theory - the more the uncertainty the stronger the preference for dividend payout.

Pricing efficiency of the S&P 500 index market: Evidence from the Standard & Poor's Depositary Receipts

Abstract Daily opening, noon, and closing prices of Deutschemark and Japanese yen futures are examined for the efficiency of the foreign exchange futures (FXF) market. Variance ratio and multiple variance ratio tests, are employed. The prices are found to be serially uncorrelated. This random walk behavior sheds light on the differences between the FXF and commodity or equity markets. The conclusions suggest that the FXF market is a 24-hour global market, reflecting a disparity with equity markets where round-the-clock trading is advocated since the high volatility during market opening would be eliminated, leading to potential cost reductions for traders as spreads are lowered.