Could the Extended Trading of CSI 300 Index Futures Facilitate Its Role of Price Discovery?

• Published date: 01 July 2017
• Author: Sungbin Sohn,Xiaofeng Zhang
• DOI: http://doi.org/10.1002/fut.21804
• Date: 01 July 2017

Could the Extended Trading of

CSI 300 Index Futures Facilitate

Its Role of Price Discovery?

Sungbin Sohn *and Xiaofeng Zhang

This study examines the role of extended CSI 300 Index futures trading in price discovery.

As a prerequisite for the facilitation of price discovery, we first confirm that extended trading

is weak-form efficient and driven by information. We find that the predictability of futures

returns during extended trading on the index’s overnight returns is strong and improving.

More importantly, compared to the index, its futures price exhibits stronger price leadership,

particularly in the early synchronous trading hours. Evidence suggests that extended trading

facilitates price discovery at the opening and in the early trading hours of the stock market.

©2016 Wiley Periodicals, Inc. Jrl Fut Mark 37:717–740, 2017

1. INTRODUCTION

Two important strands of the stock index futures literature are its price discovery role for the

associated cash index and the information content of extended trading. This study attempts

to analyze these two strands in a single framework using Chinese data with a relatively long

time span.

Price discovery is the process by which new information is incorporated into asset prices.

Given two closely related markets, the market with faster information processing would be

expected to play the dominant role in price discovery. A stock index futures market and its

underlying cash market are a classic example of two closely related markets. A large body of

research has found evidence that stock index futures markets respond to the arrival of new

information faster than the corresponding cash market index due to lower transaction costs

and the lack of short-sale restrictions and hence lead changes in its associated stock index in

the United States (Chan, 1992; Chou & Chung, 2006; Hasbrouck, 2003; Kawaller, Koch,

& Koch, 1987; Stoll & Whaley, 1990), the United Kingdom (Abhyankar, 1995; Tse, 1999),

Japan (Iihara, Kato, & Tokunaga, 1996), and Hong Kong (So & Tse, 2004).1Covrig, Ding,

Sungbin Sohn is an Assistant Professor of finance at Peking University HSBC Business School, Shenzhen,

China. Xiaofeng Zhang is a research analyst at Helijin Technology Shanghai Ltd., Shanghai, China. The

authors thank Bob Webb(the editor) and an anonymous reviewer for their useful comments and suggestions.

JEL Classification: G12, G13

*Correspondence author,Peking University HSBC Business School, University Town, Nanshan District, Shenzhen,

518055, China. Tel: +86-755-2603-5324, Fax:+86-755-2603-5344, e-mail: sungbin.sohn@phbs.pku.edu.cn

Received November 2015; Accepted July 2016

1The two markets could have bidirectional interactions, but the index futures markets tend to have stronger effects

on the cash markets (Booth, So, & Tse, 1999; Pizzi, Economopoulos, & O’Neill, 1998). An exceptional case is found

by Wahab and Lashgari (1993), who report that the spot-to-futures leadership was more pronounced in both the

United States and the United Kingdom from January 1988 to May 1992.

The Journal of Futures Markets, Vol. 37, No.7, 717–740 (2017)

©2016 Wiley Periodicals, Inc.

Published online 19 August 2016 in Wiley Online Library (wileyonlinelibrary.com).

DOI: 10.1002/fut.21804

718 Sohn and Zhang

and Low (2004) show that even domestic stock index futures traded on a foreign market can

play a significant price discovery role for the domestic stock index.

Another interesting strand of research on stock index futures markets is the informa-

tion content of prices during extended trading periods. In many countries, the stock index

futures market opens earlier and/or closes later than the underlying cash market, and many

researchers have documented the implications of extended trading periods. Chang, Jain,

and Locke (1995) argue that the behavior of the US stock index futures market during

the post-close extended trading sessions is consistent with private information-driven trades

rather than mere liquidity trades. Cheng, Jiang, and Ng (2004) and Hiraki, Maberly, and

Takezawa (1995) find that in Hong Kong and Japan, respectively, the index futures return

during extended trading sessions has a significant predictive power on the index’s overnight

return, which implies information-based transactions. Chan (2005) finds that activities dur-

ing the extended trading of Hang Seng Index futures are related to private information, rather

than to public information or noise. Studies on the extended trading of stocks, rather than

futures, also report similar results of information-based trading. Barclay and Hendershott

(2003) find that in the US stock market, relatively low trading volume in extended hours

can generate noisy but significant price discovery. Biais, Hillion, and Spatt (1999) and Cao,

Ghysels, and Hatheway (2000) find evidence that there is significant price discovery during

the pre-opening period in the Nasdaq and the Paris Bourse, respectively.

Despite the large number of studies on these two strands, to the best of our knowledge,

few papers have combined them in a single framework to obtain a comprehensive under-

standing about how the extended trading of index futures influences futures-cash price lead-

ership.2In addition, many studies on emerging markets use a relatively short data span, and

their results have not resulted in a unanimous conclusion. For example, studies in China

(Chen & Lin, 2013; Yang, Yang, & Zhou, 2012), Greece (Kavussanos, Visvikis, & Alexakis,

2008), Mexico (Zhong, Darrat, & Otero, 2004), South Korea (Min & Najand, 1999), and

Taiwan (Lee, Chien, & Huang, 2007) use a data period with a maximum of 3 years. Among

them, Yanget al. (2012) use only two and a half months of data and report that in the Chinese

stock market, it is the cash market that plays a dominant role in price discovery, which is

inconsistent with the existing literature.

For a comprehensive understanding of the two strands of the stock index futures liter-

ature, particularly in emerging markets, this study uses a relatively long data period in the

Chinese markets and investigates whether the extended trading of CSI 300 Index futures

facilitates price discovery—not only at the stock market opening but also in the stock-futures

synchronous trading hours. Because there is likely to be substantial information asymmetry

and a high ratio of informed to uninformed trading in the morning (Hua, Liu, & Tse 2016),

pre-open extended trading could provide traders with preparation time to fully digest the

overnight news. The post-close extended trading session could allow traders to make poten-

tial portfolio adjustments based on the entire day’s information without interruption from

the cash market. Combined, the equilibrium price in the extended trading session could

work as a rational reference for the cash market, and extended trading supposedly facilitates

price discovery. In addition, this role may not be limited to the cash market opening because

information processing may take time (Hou, 2007; Hou & Moskowitz, 2005). This study

empirically tests this alleged role of extended index futures trading.

We first investigate the information content of the CSI 300 Index futures in the ex-

tended trading sessions because the role of price discovery could be achieved only if the

2After we submitted the initial draft, a similar but different work by Hua et al. (2016) became available online. This

study differs from theirs in that it considers the time-varying effect of extended futures trading and seeks to provide

evidence against an alternative explanation. See Section 4 for details.