The Influence of Trading Frequency on Lead-Lag Effect Between Index Futures and Stock Index in Malaysia

Abstract

The presence of lead-lag effect between index futures and stock index has lead finance researchers to focus on identifying the source of such phenomenon.  In general, index futures play an important role in the price discovery process since it is found that index futures leads the stock index in reacting to the arrival of new information. Such phenomenon is attributed to the problem of stale prices among some components of stock index. The problem arises due to nonsynchronous trading as well as infrequent trading among inactive component stocks, resulting in stock index reporting weightage value of past prices unlike index futures, which is being updated constantly. This study examines the influence of trading frequency among component stocks on the presence of lead-lag effect between the two markets in Malaysia. The period of study runs from January 2000 to October 2003. It employs regression analysis using system estimators approach. The result shows that index futures does not only lead the inactive component stocks but also the active component stocks. As such, the finding contradicts the proposed theory, which stipulates that the presence of lead-lag effect is due to the problem of infrequent trading among inactive component stocks.  Therefore, consistent with Chan (1992) and Martikainen et al. (1995) who investigate the same issue in the United States and Finland, this study provides empirical evidence that trading frequency does not contribute towards the presence of lead-lag effect between index futures and stock index in Malaysia.