Trading protocols and price discovery: Implicit transaction costs in Indian single stock futures

• Author: Edward Curran,Vito Mollica,Jack Hunt
• Published date: 01 November 2020
• Date: 01 November 2020
• DOI: http://doi.org/10.1002/fut.22123

J Futures Markets. 2020;40:1793–1806. wileyonlinelibrary.com/journal/fut © 2020 Wiley Periodicals LLC

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1793

Received: 15 August 2019

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Accepted: 9 April 2020

DOI: 10.1002/fut.22123

RESEARCH ARTICLE

Trading protocols and price discovery: Implicit transaction

costs in Indian single stock futures

Edward Curran

1,2

|Jack Hunt

1

|Vito Mollica

1,2

1

Applied Finance, Macquarie University,

North Ryde, Sydney, New South Wales,

Australia

2

RoZetta Institute, Sydney,

New South Wales, Australia

Correspondence

Edward Curran, Applied Finance, 99

Talavera Road, North Ryde, Sydney,

NSW 2109, Australia.

Email: edward.curran@hdr.mq.edu.au

Funding information

Australian Government Research Training

Program Scholarship; Capital Markets

Cooperative Research Centre (CMCRC)

Abstract

We show how trading protocols impede the price discovery process in single

stock futures as implicit trade costs outweigh explicit costs. Despite the trade

volume dominance, trade costs advantage and leverage efficiency in futures

markets, single stock futures account for only 35% of the price discovery vis‐á‐

vis the spot market. Futures market's informational efficiency is adversely

affected by market frictions in the form of marketwide position limits, mini-

mum contract values, and margin requirements.

KEYWORDS

market wide position limits, minimum contract value, single stock futures, trading protocols

1|INTRODUCTION

Between markets in related securities, larger trading volumes are indicative of market focus, concentration, and price

discovery (Eun & Sabherwal, 2003). Save for the time value of money, the financial instrument leading price discovery

should be random. However, Fleming, Ostdiek, and Whaley (1996) show that the market with the lowest overall trading

cost, based on spreads, brokerage, and slippage costs, will react and incorporate information into prices first.

Extant research has assessed price informativeness and transaction costs across index futures, index options, and

baskets of underlying securities. With respect to index futures, Chng (2004), Fleming et al. (1996), Frino and West

(2003), Ghadhab and Hellara (2016), Hseu, Chung, and Sun (2007), Kim, Szakmary, and Schwarz (1999), Nordén

(2009), Qin, Green, and Sirichand (2019) attribute the low cost of trading index futures to their dominance in com-

pounding information quicker relative to trading a basket of equities. Fleming et al. (1996) note however that these

results are reversed for studies assessing single stocks. Stephan and Whaley (1990) show equity markets lead options

markets, while Chan, Chung, and Fong (2002) show that equity and derivative markets compound information

virtually simultaneous.

Our study extends the list of implicit transaction costs to include trading protocols and market frictions between

instruments to explain price discovery leadership between spot and derivative markets. We show that the implicit

trading costs outweigh the explicit trade costs in the volume dominant futures market. We utilize a proprietary data set

that identifies a number of unique institutional features particular to single stock futures (SSFs). We turn to the

National Stock Exchange (NSE) of India and show why the volume dominant and explicit trade cost‐efficient

derivatives market fails to lead price discovery vis‐á‐vis spot equity markets.

SSFs have not attracted a significant level of attention in the literature despite their advantageous positioning in

assessing a number of market microstructure issues, such as price discovery. Much focus has been spent on the

comparison between index futures and spot markets. However, McKenzie, Brailsford, and Faff (2001) note that studies

of indices are useful for understanding marketwide impacts, but any effect on the underlying is dissipated. The NSE