Essays on relative pricing of securities

Date
2009
Authors
Kumar, Umesh
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Abstract

In this dissertation, I examine the relative pricing of securities traded on different markets to evaluate the impact of market microstructure features. My first essay "Single-Stock Futures: Evidence from the Indian Securities Market" examines the contribution of single stock futures (SSF) contracts in price discovery for individual stocks in the Indian market. The findings indicate that trades in the stock market contribute more to price discovery than trades in the SSF market (72% and 28%, respectively), while quotes in the SSF market are more price innovative than quotes in the stock market (39% and 61%, respectively). The analysis suggests that stock and SSF trade returns have predictive ability for each other. In case of quotes, only SSF quotes have predictive ability for stock and SSF returns.

My second essay "Settlement Differences and the Law of One Price" investigates the importance of settlement procedures by analyzing stocks traded on two Indian stock exchanges with differing settlement periods. The findings suggest that the differences in settlement periods cause stock prices to vary predictably between the two exchanges. The price difference is of the order of 0.25% and it is positively related to the cost of funds for arbitrageurs. The result has implications for the relative pricing of securities such as derivatives and depositary receipts, which trade under different settlement procedures compared to their underlying securities.

My third essay "Small Trades and ADR Premiums: The Case of Indian ADRs" examines the impact of small trades on Indian ADR prices relative to the underlying stock. These ADRs trade at significant premiums that cannot be arbitraged due to Indian government regulations. The findings suggest that ADR premiums are positively related to order-imbalance of small ADR trades. The premiums associated with small trades are reversed in two weeks. Also, premiums are negatively related to the volatility implied by S&P500 index option prices (VIX).

My fourth essay "Impact of Liquidity on the Futures-Cash Basis: Evidence from the Indian Market" examines the relationship between liquidity measures and the futures-cash basis. Using daily data on the NYSE index and related futures contracts, Roll, Schwartz, and Subrahmanyam (2007) document two-way Granger causality between the futures-cash basis and the bid-ask spreads for stocks. This essay uses intra-day data on single stock futures (SSF) contracts on Indian stocks and also considers the spread on the futures contracts. While spreads in both the futures and cash markets affect futures-cash basis, the futures-cash basis Granger-causes only the bid-ask spreads for SSFs but not the stocks.

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Keywords
ADRs, finance, securities, single-stock futures
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Department
Finance