The evolution of price discovery in us equity and derivatives markets

• Author: Damien Wallace,Petko S. Kalev,Guanhua Lian
• Date: 01 September 2019
• Published date: 01 September 2019
• DOI: http://doi.org/10.1002/fut.22019

J Futures Markets. 2019;39:1122–1136.wileyonlinelibrary.com/journal/fut1122

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© 2019 Wiley Periodicals, Inc.

Received: 25 June 2018

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Revised: 17 April 2019

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Accepted: 18 April 2019

DOI: 10.1002/fut.22019

RESEARCH ARTICLE

The evolution of price discovery in us equity and derivatives

markets

Damien Wallace

1

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Petko S. Kalev

2

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Guanhua Lian

1

1

UniSA Business School, School of

Commerce, University of South Australia,

Adelaide, South Australia, Australia

2

Department of Economics and Finance,

La Trobe Business School, La Trobe

University, Melbourne, Victoria, Australia

Correspondence

Damien Wallace, School of Commerce,

University of South Australia, 37‐43 North

Terrace, City West, Adelaide, SA 5000,

Australia.

Email: damien.wallace@unisa.edu.au

Abstract

This study considers the evolution of price discovery in the S&P 500 E‐mini

futures and the corresponding exchange traded fund (SPY ETF) over the period

January 2002 through December 2013. The study reports evidence that the E‐

mini futures dominate price discovery at the beginning of the sample period.

However, from 2007 onward both the SPY ETF and E‐mini futures contribute

similar portions to the price discovery process. The level of price discovery is

significantly influenced by volume measures and relative levels of transaction

costs for both securities.

KEYWORDS

exchange traded funds, futures, information share, price discovery, stock

JEL CLASSIFICATION

G14

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INTRODUCTION

This study considers the evolution of price discovery in the US equity and derivatives markets for the period January

2002 through December 2013. More specifically, the paper investigates the incorporation of new information into prices

of two important and highly liquid securities that track the S&P 500 index, the E‐mini futures contract and the SPY

exchange traded fund (ETF). The increasing popularity of ETFs, and in particular the SPY ETF, results in greater

analyst coverage and higher levels of trading activity. The significant growth and trading volume of ETFs over the past

two decades are evidence to their popularity and ease of transaction. The growth of ETFs is also attributed to their

capacity for investors to gain exposure to a diverse range of markets, investment styles, and sectors.

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These factors have

resulted in changing market dynamics of both of these securities, which requires an investigation to examine the extent

of these effects on the price discovery process. The price discovery process of these two securities is expected to be

influenced, in part, by the evolution in trading activity and an increased awareness of the SPY ETF and ETFs in general.

Utilizing the Putniņš’s (2013) information leadership share (ILS) measure, the findings indicate that the price

discovery has changed significantly during the period of the study. While the early period the E‐mini futures market has

been dominating the SPY ETF in price discovery, from around the start of 2008, the price discovery is approximately

equal for each of the futures and the ETF. The results provide a number of insights into the trading behavior in these

two important markets. First, the results provide evidence to suggest that the difference in the costs, measured as the

relative effective spread, between the ETF and the E‐mini market is a key determinant in the level of the price discovery

for a security. Second, the findings indicate that relative levels of trading activity, such as dollar turnover, the size of

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The number of ETFs has increased from just 450 in 2005 to over 5300 in 2017. Assets under management have increased from US$417 billion to over US$4.6 trillion for the same time period

(etfgi.com; 2018). Both the S&P 500 tracker fund (SPY) and the E‐mini futures contract are highly traded.