Multi-scale Lead-Lag Relationship between the Stock and Futures Markets: Malaysia as a Case Study

Jusoh, Hashim and Bacha, Obiyathulla and Masih, Abul Mansur M. (2014): Multi-scale Lead-Lag Relationship between the Stock and Futures Markets: Malaysia as a Case Study.

Abstract

There is a considerable literature relating to a lead-lag relationship between the stock index (spot) and stock index futures markets in developed countries compared to emerging countries. The analysis of this relationship in an emerging market based on a different investment horizon is significant for both academic and trading purposes. In this study, we analyze the lead-lag relationship between stock index and stock index futures in Malaysia. We use a new approach based on the Continuous Wavelet Transform (CWT) and the Discrete Wavelet Transform (DWT). The results show variability of the lead-lag relationship across frequency ranges and time scales, and also occasional in-phase behaviour between both markets. The relationships between stock index and stock index futures are shown to evolve over time with non-homogeneous trends across different time scales. Some strong correlations have been found in lead-lag interactions between the markets. The result from this study would provide a better picture of a current derivatives market in emerging countries, specifically in Malaysia. Hopefully it will shed some light in furthering the development of Islamic equity futures within the Islamic capital market, therefore will encourage Islamic asset managers to use derivatives as a hedging tool to protect their funds’ value.

• Item Type: MPRA Paper
• Language: English
• Keywords: Stock Index, Stock Index Futures, Lead-Lag Relationship, Continuous Wavelet Transform, Discrete Wavelet Transform
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling; G - Financial Economics > G3 - Corporate Finance and Governance

References

Abdullah, M., Mohd Nasir, A., Mohamad, S., Aliahmed, H. J., & Hassan, T. (2002). The temporal price relationship between the stock index futures and the underlying stock index : evidence from Malaysia. Pertanika Journal of Social Sciences and Humanities, 10(1), 73–84.

Addison, P. S. (2002). The illustrated wavelet transform handbook (pp. 1–351). Bristol: IOP Publishing Ltd. doi:10.1887/0750306920

Aguiar-Conraria, L., & Soares, M. J. (2010). The continuous wavelet transform: A primer (No. 16). University of … (pp. 1–43). Retrieved from http://www.economics-ejournal.org/economics/journalarticles/2011-16/references/@@export

Bacha, O. I. (2012). Financial derivatives: Markets and applications in Malaysia (pp. 1–432). Selangor, Malaysia: McGraw-Hill.

Bacha, O. I., & Mirakhor, A. (2013). Islamic capital markets: A comparative approach (pp. 1–448). Singapore: John Wiley & Sons.

Barunik, J., Vacha, L., & Kristoufek, L. (2011). Comovement of Central European stock markets using wavelet coherence: evidence from high-frequency data (No. 22/2011) (pp. 1–18). Prague. Retrieved from http://ies.fsv.cuni.cz

Bruzda, J. (2009). Examination of the cost-of-carry formula for futures contracts on WIG20 . Wavelet and nonlinear cointegration analysis. In Coping with the Complexity of Economics in New Economic Windows (pp. 81–110). Milan, Italy: Springer.

Bruzda, J. (2010). European equity market integration and optimal investment horizons–evidence from wavelet analysis. Dynamic Econometric Models, 10, 15–30.

Bursa Malaysia. (2009). Annual report 2009. Retrieved from http://www.bursamalaysia.com.

Bursa Malaysia. (2011). Annual report 2011. Retrieved from http://www.bursamalaysia.com.

Crowley, P. M. (2007). An guide to wavelets for economists. Journal of Economic Surveys, 21(2), 206–267. doi:10.1111/j.1467-6419.2006.00502.x

Ernst & Young. (2011). Islamic Funds and Investments Report 2011: Achieving Growth in Challenging Times (pp. 1–50). Retrieved from www.ey.com

Fernandez, V. (2008). Multi-period hedge ratios for a multi asset portfolio when accounting for returns co-movement. Journal of Futures Markets, 28(2), 182–207. doi:10.1002/fut.20294

Fung, A. K.-W., Lam, K., & Lam, K.-M. (2010). Do the prices of stock index futures in Asia overreact to U.S. market returns? Journal of Empirical Finance, 17(3), 428–440. doi:10.1016/j.jempfin.2009.12.006

Gallegati, M. (2008). Wavelet analysis of stock returns and aggregate economic activity. Computational Statistics & Data Analysis, 52, 3061–3074. doi:10.1016/j.csda.2007.07.019

Gencay, R., Selcuk, F., & Whitcher, B. (2001). Differentiating Intraday Seasonalities Through Wavelet Multi-Scaling October 1999. Physica A, 289, 543–556.

Gencay, R., Selcuk, F., & Whitcher, B. (2002). An introduction to wavelets and other filtering methods in finance and economics (pp. 1–359). San Diego: Academic Press.

González-Concepción, C., Gil-Fariña, M. C., & Pestano-Gabino, C. (2012). Using wavelets to understand the relationship between mortgages and Gross Domestic Product in Spain. Journal of Applied Mathematics, 2012, 1–17. doi:10.1155/2012/917247

Grinsted, A., Moore, J. C., & Jevrejeva, S. (2004). Application of the cross wavelet transform and wavelet coherence to geophysical time series. Nonlinear Processes in Geophysics, 11, 561–566.

Hasan, M. (2005). An alternative approach in investigating lead – lag relationships between stock and stock index futures markets – comment. Applied Financial Economics Letters, 1(2), 125–130. doi:10.1080/17446540500047296

Ibrahim, A. J., Othman, K., & Bacha, O. I. (1999). Issues in stock index futures introduction and trading. Evidence from the Malaysian index futures market. Capital Market Review, 7(1&2), 1–46. Retrieved from http://mpra.ub.uni-muenchen.de/13075

In, F., & Kim, S. (2006a). Multiscale hedge ratio between the Australian stock and futures markets: Evidence from wavelet analysis. Journal of Multinational Financial Management, 16(4), 411–423. doi:10.1016/j.mulfin.2005.09.002

In, F., & Kim, S. (2006b). The hedge ratio and the empirical relationship between the Stock and futures markets: a new approach using wavelet analysis. Journal of Business, 79(2), 799–820. Retrieved from http://www.jstor.org/stable/10.1086/499138

In, F., & Kim, S. (2013). Wavelet theory in finance: A wavelet multiscale approach (pp. 1–204). Singapore: World Scientific Publishing Co. Pte. Ltd.

In, F., Kim, S., Marisetty, V., & Faff, R. (2007). Analysing the performance of managed funds using the wavelet multiscaling method. Review of Quantitative Finance and Accounting, 31(1), 55–70. doi:10.1007/s11156-007-0061-8

Kamali, M. H. (1999a). Prospects for an Islamic derivatives market in Malaysia. Thunderbird International Business Review, 41(4/5), 523–540.

Kamali, M. H. (1999b). The permissibility and potential of developing Islamic derivatives as financial instruments. IIUM Journal of Economics and Management, 7(2), 73–86.

Kawaller, I. G., Koch, P. D., & Koch, T. W. (1987). The temporal price relationship between S&P 500 futures and the S&P 500 index. Journal of Finance, 42(5), 1309–1329. Retrieved from http://www.jstor.org/stable/2328529

Krichene, N. (2013). Islamic capital markets: Theory and pPractice (pp. 1–888). Singapore: John Wiley & Sons. Lahsasna, A. (2013). Maqasid Al Shariah in Islamic Finance. Kuala Lumpur: IBFIM.

Lin, S., & Stevenson, M. (2001). Wavelet Analysis of the Cost-of-Carry Model. Studies in Nonlinear Dynamics & Econometrics, 5(1), 87–102. Retrieved from http://www.bepress.com/snde/vol5/Iss1/art7

Madaleno, M., & Pinho, C. (2012). International Stock Market Indices Comovements: a New Look. International Journal of Finance and Economics, 17(April 2011), 89–102. doi:10.1002/ijfe.448

Masih, M., Alzahrani, M., & Al-Titi, O. (2010). Systematic risk and time scales: New evidence from an application of wavelet approach to the emerging Gulf stock markets. International Review of Financial Analysis, 9(1), 10–18. doi:10.1016/j.irfa.2009.12.001

Mohamad, S., & Hassan, T. (2007). Asian derivative markets : Research issues. International Journal of Banking and Finance, 5(1), 1–25. Retrieved from http://epublications.bond.edu.au/ijbf/vol5/iss1/1

Mohamad, S., Hassan, T., & Ariff, M. (2007). Research in an emerging Malaysian capital market: a guide to future direction. International Journal of Economics and Management, 1(2), 173–202.

Naccache, T. (2011). Oil price cycles and wavelets. Energy Economics, 33(2), 338–352. doi:10.1016/j.eneco.2010.12.001

Ogden, R. T. (1997). Essential wavelets for statistical applications and data analysis (pp. 1–206). Cambridge,USA: Birkhauser Boston.

Pati, P. C., & Rajib, P. (2011). Intraday return dynamics and volatility spillovers between NSE S&P CNX Nifty stock index and stock index futures. Applied Economics Letters, 18(6), 567–574. doi:10.1080/13504851003742442

Percival, D. B., & Walden, A. T. (2000). Wavelet methods for time series analysis. (pp. 1–594). Cambridge: Cambridge University Press.

Performance Management and Delivery Unit (PEMANDU). (2010). Economic transformation programme: a roadmap for Malaysia (pp. 1–605). Retrieved from www.pemandu.gov.my Ramsey, J. B. (2002). Wavelets in economics and finance: Past and future. Studies in Nonlinear Dynamics & Econometrics, 6(3), 1–27.

Ramsey, J. B., & Lampart, C. (1998). Decomposition of economic relationships by timescale using wavelets. Macroeconomic Dynamics, 2, 49–71.

Securities Commission Malaysia. (2011). Capital Market Masterplan 2: Malaysia (pp. 1–98). Kuala Lumpur. Retrieved from www.sc.com.my

Securities Commission of Malaysia. (2009). Resolutions of the Securities Commission Shariah Advisory Council (Second Edi., pp. 1–184). Kuala Lumpur: Securities Commission.

Shaharuddin, A., Mas’ad, M. A., Safian, Y. H. M., Shafii, Z., Salleh, A. Z., Alias, M. H., … Khir, M. F. A. (2012). Fatwas on Islamic capital markets: a comparative study between Malaysia and Gulf Co-Operation Council ( GCC ). ISRA Research Paper, No:40/2012(2012), 1–36.

Stoll, H. R. ., & Whaley, R. E. (1990). The dynamics of stock index and stock index futures returns. Journal of Financial and Quantitative Analysis, 25(4), 441–468. Retrieved from http://www.jstor.org/stable/2331010

Sutcliffe, C. M. S. (2006). Stock index futures (Third Edit., pp. 1–512). Hampshire GU11 3HR: Ashgate Publishing Limited.

Torrence, C., & Compo, G. P. (1998). A Practical Guide to Wavelet Analysis. Bulletin of the American Meteorological Society, 79(1), 61–78.

Torrence, C., & Webster, P. J. (1999). Interdecadal changes in the ENSO–Monsoon system. American Meteorological Society, 2679–2690.

Vacha, L., & Barunik, J. (2012). Co-movement of energy commodities revisited: Evidence from wavelet coherence analysis. Energy Economics, 34(1), 241–247. doi:10.1016/j.eneco.2011.10.007

Walnut, D. F. (2004). An introduction to wavelet analysis (pp. 1–449). New York: Springer. doi:10.1007/978-1-4612-0001-7

Yakob, N. A. (2004). Pengaruh kekerapan dagangan terhadap kesan pimpin-lengah antara pasaran niagaan kedepan dengan indeks saham di Malaysia. Jurnal Pengurusan, 23, 27–46.

Yakob, N. A. (2005). Hubungan antara pasaran niagaan ke depan indeks saham dengan pasaran saham di Malaysia. Jurnal Ekonomi Malaysia, 39, 3–23.