Nonlinear dynamics in arbitrage of the S&P 500 index and futures: A threshold error-correction model

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Using a three-regime threshold error-correction model, we investigate the nonlinear dynamics of the S&P 500 index and futures. First, using the SupLM statistic, we report estimates of two thresholds for the three-regime model to explain the nonlinear dynamics in arbitrage of the S&P 500 index and futures. This provides empirical evidence of the no-arbitrage band predicted by the cost-of-carry model. Second, using quasi-maximum likelihood estimation, we demonstrate that those indexes that are located outside the no-arbitrage band are a nonlinear stationary process of mean-reversion to the no-arbitrage band. However, index and futures that are located within the no-arbitrage band are non-stationary. Third, we confirm an earlier finding that futures price leads the nonlinear mean-reverting behavior of the index but not vice versa. Impulse response function analysis and forecasting performance of three-regime error-correction model reinforce our findings and our estimation results are robust with different specifications of pricing error terms and endogenous variables. (C) 2009 Elsevier B.V. All rights reserved.
Publisher
ELSEVIER SCIENCE BV
Issue Date
2010-03
Language
English
Article Type
Article
Keywords

STOCK INDEX; NUISANCE PARAMETER; TRANSACTION COSTS; COINTEGRATION; MARKET; ADJUSTMENT; TESTS; RETURNS; CASH

Citation

ECONOMIC MODELLING, v.27, pp.566 - 573

ISSN
0264-9993
URI
http://hdl.handle.net/10203/25490
Appears in Collection
RIMS Journal Papers
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