Price Formation in Spot and Futures Markets: Exchange Traded Funds vs. Index Futures

Abstract

This article examines the issue of price leadership between a derivative and its underlying—in this case, the German DAX index and an exchange-traded fund (ETF) based on the DAX portfolio of stocks. Previous researchers had found that changes in DAX futures prices led movements in the underlying DAX index. Schlusche tests to see whether that result carries over to DaxEx, the DAX ETF traded on the EUREX exchange. He shows that both markets contribute to price discovery, but the influence of the DAX futures is about three times greater than the influence of the ETF. Digging more deeply into the relationship, he finds that the relative importance of the two markets in price determination varies over time, with the ETF carrying greater weight in times of higher volatility, while variations in relative trading volume, which he takes to be a measure of relative liquidity, do not seem to matter.