An Alternative Approach To Investigating Lead-lag Relationships Between Stock And Stock Index Futures Markets

In the absence of market frictions, the cost of carry model of stock index futures pricing predicts that returns on the underlying stock index and the associated stock index futures contract will be perfectly contemporaneously correlated. Evidence suggests, however, that this prediction is violated with clear evidence that the stock index futures market leads the stock market. We argue that traditional tests, which assume that the underlying data generating process is constant, might be prone to overstate the lead-lag relationship. Using a new test for lead-lag relationships based on cross correlations and cross bicorrelations we find that, contrary to results from using the traditional methodology, periods where the futures market leads the cash market are few and far between and when any lead-lag relationship is detected, it does not last long. Overall, our results are consistent with the prediction of the standard cost of carry model and market efficiency.