A trading strategy based on the lead–lag relationship between the spot index and futures contract for the FTSE 100

A trading strategy based on the lead–lag relationship between the spot index and futures contract for the FTSE 100

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Article ID: iaor20013170
Country: Netherlands
Volume: 17
Issue: 1
Start Page Number: 31
End Page Number: 44
Publication Date: Jan 2001
Journal: International Journal of Forecasting
Authors: , ,
Keywords: forecasting: applications
Abstract:

This paper examines the lead–lag relationship between the FTSE 100 index and index futures price employing a number of time series models. Using 10-min observations from June 1996–1997, it is found that lagged changes in the futures price can help to predict changes in the spot price. The best forecasting model is of the error correction type, allowing for the theoretical difference between spot and futures prices according to the cost of carry relationship. This predictive ability is in turn utilised to derive a trading strategy which is tested under real-world conditions to search for systematic profitable trading opportunities. It is revealed that although the model forecasts produce significantly higher returns than a passive benchmark, the model was unable to outperform the benchmark after allowing for transaction costs.

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