Empirical Results on Market Efficiency and Its Analysis

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Empirical Results on market efficiency and its analysis

During the late 1990s, there existed several market frictions and phenomena unique in the Korean futures and stock markets that would hinder a quick adjustment of market prices to information. In order for futures trading to effectively reduce market frictions in the stock market, it is necessary that information created in the futures market be transmitted to the stock market freely and quickly. When futures trading introduce in Korea in 1996, several market regulations including daily price change limit such as “circuit breakers” and “sidecar system,” restrictions on foreign ownership of Korean stocks, and inactive program trading made it almost impossible to arbitrage between the futures market and the stock market.

First, circuit breakers were designed to reduce market volatility in the short run, and adopted in both Korean futures and stock markets. Since the introduction of futures trading on the KRX in 1996, circuit breakers were operated only one time in 1996 but 49 times each in 1997 (during the last two months of November and December) and 1998. Hence, circuit breakers were put in operation mostly after the IMF financial crisis in October 1997. The Period IV(post-options trading period) overlaps to a large extent with the IMF financial crisis period. Hence, circuit breakers appear to have been effective in reducing substantial market volatility resulting from the financial crisis during Period IV. On the other hand, as circuit breakers halt the regular trading process, it effectively restricts the production and smooth flow of information from futures market to stock market. As a consequence, circuit breakers seem to have restricted the trading efficiency of...

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...ormation would become more valuable to investors who intend to price non-KOSPI 200 stocks than to those who intend to price more recognized KOSPI 200 stocks. If so, the futures trading would generate more trading in non-KOSPI 200 stocks, leading to a relatively large increase in both spot price volatility and trading efficiency of non-KOSPI 200 stocks, compared to KOSPI 200 stocks.

Works Cited

Jae Ha Lee, February 2002, Index Arbitrage with the KOSPI 200 Future

Leading Futures Market KRX, Korea Exchange

Ross, S. A., 1989, Information and Volatility: The No-arbitrage Martingale Approach to Timing and Resolution Irrelevancy, Journal of Finance 44, 1-17.

Sung C. Bae, Taekho Kwon, and Jongwon Park, 2004, Futures Trading, Spot Market Volatility, and Market Efficiency: The Case of the Korean Index Futures Markets, Journal of Futures Markets 24, 1195-1228
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