Lead-lag Relationship between the Implied Expected Growth Rate of Index Futures and the Return of the Index Spot

The impact of market imperfections is tremendous. They influence not only the pricing of financial assets, but also the dynamic relationship among financial instruments. Hsu and Wang (2004) develop a pricing model of stock index futures in imperfect markets, providing a method for estimating the implied expected growth rate. By using the vector auto regression (VAR) model, Granger causality test, and generalized impulse response function (GIRF), this study investigates the lead-lag relationship between the expected growth rate implied by the prices of index futures and the rate of return of the underlying index spot. The empirical result shows that the lead-lag relationship is weaker in the mature US markets than in the emerging Taiwanese markets. Moreover, it also shows a less significant lead-lag relationship in the US markets as Taiwanese markets do. The empirical evidence supports the hypothesis that the lead-lag relationship between the implied expected growth rate and the index spot return should become weaker as the degree of market imperfection decreases.