Abstract:
This thesis investigates the impact of tick size reduction on spot index liquidity and in
turn on the inter-market pricing relationship between spot and futures indices. Three
empirical chapters are presented. The first study investigates the impact on the spot
index liquidity in emerging Malaysian capital market. To the best of our knowledge, we
are first to investigate this issue. We find higher trading volume following tick size
reduction. Further, we find lower mispricing between the spot and futures indices after
the reduction. This is an indication that traders benefit from the lower tick sizes. In our
second study, the price discovery role of the index futures is assessed. We find that the
index futures adjust to equilibrium level ahead of its underlying. Interestingly, the spot
index adjusts to equilibrium level at a higher speed in comparison to pre-reduction
period. This implies that the lowering of tick sizes facilitates better incorporation of
stock specific information. Altogether, the lowering of tick sizes seems to improve
index futures price discovery role. In our third paper, we investigate the effectiveness of
the index futures as a hedging instrument. We find evidence that the ability of the
futures in reducing price risk is greatly enhanced due to the positive impacts of the
lower tick sizes.
