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Title: The dynamics of price discovery in the two-tier Brussels stock exchange
Authors: Bui, Thi Ngoc Tuan
Sercu, Piet
Issue Date: 2008
Abstract: In this paper, we investigate the dynamics of price discovery in the Brussels Stock Exchange for the spot and forward stock markets. Specifically, we quantitatively analyze each market's process in impounding new fundamental information about a stock's value into its market price. Similar to the permanent-transitory decomposition procedure put forward by Gonzalo and Ng (2001), we use a vecm (Vector Error Correction Model) and decompose the vecm residuals into the permanent and transitory innovations. However, we adjust their procedure to accommodate for the asynchronism problem in the Brussels forward and spot stock exchange.
From the impulse response functions of the derived structural cointegration model after the decomposition, we apply the price discovery measure proposed by Yan and Zivot (2007), which is the absolute magnitude of cumulative price errors in the process of reflecting a one-unit change in the permanent innovation. In particular, we investigate which market makes less errors while incorporating the full one-unit increase in the permanent innovation into its price. Our finding is that the spot market outperforms the forwards one in the price discovery process.
This result contradicts the price discovery role conventionally ascribed to the forward market.
Publication status: published
KU Leuven publication type: IR
Appears in Collections:Research Center International Finance, Leuven

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