Abstract
This paper examines the price discovery process of the nascent gold futures contracts in the Multi Commodity Exchange of India (MCX) over the period 2003 to 2007. The study employs vector error correction models (VECMs) to show that futures prices of both standard and mini contracts lead spot price. We find that mini contracts contribute to over 30% of price discovery in gold futures trade even though they account for only 2% of trading value on the MCX. Our finding reveals that trades initiated in mini contracts are much more informative than what the size of their market share of volume suggests.
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Notes
Mendelson (1987) defines a fragmented market as one where orders are decomposed into a number of disjoint subsets and when an asset is traded in a number of different locations.
For example, the Chicago Board of Trade (CBOT) offers full (100 oz) and mini gold (33.2 oz) futures contracts. The MCX offers standard (1 kg) and mini gold futures (100 g) contracts.
As the world’s second largest retail consumer of gold, China has recently introduced gold futures trading earlier in 2008.
MCX accounts for over half of gold futures trading activity in India. Both MCX and NCDEX have similar structures. However, activity on NCDEX is largely driven by regional domestic crops whereas activity on MCX revolves around precious metals and crude oil.
Among the three major national commodity exchanges, MCX account for almost 60% of total commodity trading.
Large size gold futures contracts, known as High Net worth Individual contracts for trading unit of 3 kg was available earlier. However, due to limited interest, these contracts only existed only for a short period of time. To target smaller traders, MCX also launched an even smaller contract size of 8 g called the “Gold Guinea” on May 8, 2008.
See details of proof in Baille et al. (2002).
To determine the appropriate number of lags, we first consider specifying a VAR order p, and obtain the optimal number of lags equal to five according to Schwarz information criterion (SIC). This criterion is applicable for choosing the number of lagged differences in a VECM because p − 1 lagged differences in a VECM correspond to a VAR order p. (See Lütkepohl (2005)). Hence, for consistency and comparability, our VECMs will use the lag length of four throughout the paper.
Note that the trading unit of mini gold futures is 100 g per contract. Based on the cumulative gold trading volume of 460,543 kg for the mini contracts, this works out to be approximately 4.61 ((460,543 kg × 1,000 g)/100 g) million contracts or 17% of total contracts traded over the sample period.
Although not shown, we perform VAR models between returns of standard and mini contracts and between the volume of standard and mini contracts and find that the price and volume of mini contracts follow the trend of standard contracts.
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Acknowledgements
We would like to thank anonymous referees of this journal. The authors acknowledge research support from the Master in Finance program, Thammasat Business School.
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Pavabutr, P., Chaihetphon, P. Price discovery in the Indian gold futures market. J Econ Finan 34, 455–467 (2010). https://doi.org/10.1007/s12197-008-9068-9
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DOI: https://doi.org/10.1007/s12197-008-9068-9