Price discovery in introducing Exchange Trade Fund (ETF) into Taiwan stock market

Authors: Yih-Wenn Laih, Chun-An Li

Journal: Chiao Da Management Review. Jun. 2006, 26(1): 119-141.

Keywords: Exchange trade fund; Taiwan index futures; Price discovery; Permanent-Transitory model; Information share model

Abstract:
This paper investigates the price discovery and the contribution of each index-related security to the evolution of an implicit “optimal forecast” index price in introducing Exchange Trade Fund (ETF) into Taiwan Stock Market: the index futures, spot index, and ETF. Using matched synchronized intra-day trading data, we find that the index future, spot index and ETF are cointegrated markets with one common stochastic trend. Two well-known common factor models, the permanent-transitory model proposed by Gonzalo and Granger (1995) and the information share model proposed by Hasbrouck (1995) are used to measure the contribution of these markets to price discovery process. This study uses TEJ intra-day data from June 30, 2003 through September 30, 2003. In both models, we find that the index future contributes the most to the price discovery process. ETF has more contribution to the price discovery process than the spot index has, but the contributions of spot index and ETF are not significance.