Market Efficiency and Volatility Spill over in Spot & Futures Currency Market

Abstract

The present study has analysed the long term relationship between spot and future prices of currency (dollar) for the period of study between 01/06/2009 and 10/07/2013. The spot and future prices of the currency is found to have long term relationship which is supported by the existence of an error correction mechanism called arbitrage. The error correction mechanism restores the equilibrium relationship whenever disequilibrium takes place between the two markets. It is the spot price which corrects the disequilibrium in the market. The study also finds the presence of unidirectional causality in the currency market wherein the spot causes the future. Using Impulse response function,it is found that significant and higher response of future price to the spot price shocks of dollar and also Volatility spill over was from the spot price to the future price whereas, there was no evidence of volatility spill over from future to spot price.