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UNIVERSITI PUTRA MALAYSIA

A STUDY ON THE LEAD AND LAG RELATIONSHIP

BETWEEN THE KUALA LUMPUR STOCK EXCHANGE

COMPOSITE INDEX FUTURES CONTRACT AND ITS UNDERLYING

KUALA LUMPUR STOCK EXCHANGE COMPOSITE INDEX

MAHDHIR ABDULLAH

GSM 2001 12

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A STUDY ON THE LEAD AND LAG RELATIONSHI BETWEEN THEKUALA LUMUR STOCK EXCHANGE COMOSITE DEX FUTURES

CONTRACT AND ITS UNDERLYG KUALA LUMUR STOCKEXCHANGE COMOSITE DEX

By 

MAHDHIR ABDULLAH

Thesis Submied in Fullmen of he Requiremen for heDegree of Maser of Science in heGraduae School of Managemen

Universii ura Malaysia

July 2001

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bstract of thess resented to the Senate ofUnverst Putra Malaysa n llmentof the requrement for the deree of Master of Scence

A SUDY ON H LAD AND LAG RLAONSHP BWN HKUALA LUMPUR SOCK XCHANG COMPOS DX FUURS

CONRAC AND S UNDRLYG KUALA LUMPUR SOCKXCHANG COMPOS NDX

y

MAHDH ABDULLAH

uly 200

Chairman: Professor Annuar Mohd Nasir, PhD.

Faculy: Graduae School Of Managemen

The birth of the uala Lumur Stock xchane Cmosite ndex tures cntract

(FL in December 1 995 creates a lot of oortunities for research n the area of

nancial derivatives This aer looks into the lead and la relationshi beteen

the FL retus and the Kuala Lumur Stock xchane Comosite ndex (LS

C) returns snce the nceton of te stock ndex tures tradn n December 1 995

until December . The ve-year eriod s semented nto three suberods to

see the lead-la behavur under dierent market volatility levels The three

suberods are Suberod 1 frm nceton to une 1997, Suberod from uly

1997 to Setember 1998, and Suberiod 3) from October 1998 to December .

The rst suberod reects the erd of stable rices and thin tures tradin

vlume the second suberod reresents the erod f hihly volatile market and

hue tures tradin volume and the trd suberod reects the eriod of

reasonably stable rices and fairly hh tradin volume n ths study a mulile

reresson model s used as the methodoloy to test for the lead and la

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relationshi beteen the stock index tures returns and LS C rets. The

study nds that there is a strong contemoraneous relationshi and there exists a

lead eect om the tures market to the sot market by one day in suberiods 1

and 3. Suberiod shos a mix lead-lag relationshi beteen the to markets For

the hole eriod under revie the relationshi has been found to be ambiguous

and inconclusive

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keig merupkn emph psrn yng gk sbi dn jumh dgngn yng

gk inggi. Di dm kjin ini mde regresi diunkn unuk menji ubngn

se ku i nr knrk hdpn neks Kmps dn KLSE Kjin ini

mendpi bh ujud hubungn serenk di nr kedu-du psrn dn

ujud se ms di mn psrn hdpn didpi mendhuui psrn uni

sem su hri di dm jngkms pertm dn keig. Di dm jngkms

kedu, hubungn se ku di nr kedu-du psrn didpi bercmpur

cmpur. Unuk emph keseuruhn hubungn di nr jedu-du psrn

didpi bercmpur-cmpur

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ACKNOWLEDGEMENTS

n he name f ah he ms gracis he ms merci By he ish f

ah he mighy, his piece f rk has reached is cmpein Bessing and

peace be pn Prphe Mhammad sa

ish epress my immense graide and hearfe hanks my

sperisr Prfessr Dr nnar Mhd Nasir hse aabe gidance has made

his disserain maeriaise Specia acnedgmen as ges ssciae

Prfessr Dr Shamsher Mhamad Ramidii and Dr Hsn Jher iahmed h

si in he sperisry cmmiee fr heir grea cnribins in his sdy d

as ike eend my endess hanks En Taq Hassan fr his ers in

giding me hrgh he crse f carrying he research

cknedgemens are as de my beed mher, Pan Faimah Haji

b Rahman and my ae faher, ahyarham bduah Haji bd Rahman fr

heir sppr and encragemen ards pursing higher edcain Specia

dedicains my ceages Dr Baachander Krishnan Gr, Madam Sanha

Vaihiingam, Dr heng Ming Y, Ms hng Lee Lee, Pan Zarehan Seama

and Pr LLN Sarma h hae en me heir nedge and eperise in

aris eds d as ike epress my specia hanks he Maaysia

Deraies Echange Bhd he Kaa Lmpr Sck Echange he Gradae

Sch f Managemen Uniersii Pra Maaysia and Mimedia Uniersiy fr

priding srces f daa and references

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ceify ha an Eaminain Cmmiee me n 1  Juy 2001 cnduc he naeaminain f Mahdhi bduah n his Mase f Science hesis enied Sudy n Th ad nd ag ainhi n Th Kuaa Lumu Sck

Echange Cmsi nd Fuus Cnac nd s Undeying Kuaa LumuSck Echange Cmsi nde" in accdance ih Uniesii PeanianMaaysia High Dg) c 80 d Unisii Pranian Maaysia HighDgee) eguains 18 1 The Cmmi cmmnds ha he candidae beaaded he an dg Membs f h Eaminain Cmmi asfs

Zaina bidin Kidamsscia Prfess

Gaduae Sch f ManagmenUniesii Pua MaaysiaChaiman)

nnua Mhd. Nasi PhD PfssFacuy f Ecnmics and ManagemnUnisii ua MaaysiaMembe)

Shamshe Muhamad amadii PhD

sscia PfessFacuy f Ecnmics and ManagemnUniesii Pua MaaysiaMembe)

Husn Jhe iahmd, PhD cuFacuy f Ecnmics and ManagmenUniesii Pua Maaysia

BT SLEH PhDs ciae PfessDeuy DeanGaduae Sch f ManagemenUniesii Pua Maaysia

Dae

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Ths hss submd h Sna fUnvrs Pura Maaysa has bn accpdas mn f h rqurmn fr h dgr f Masr f Scnc

viii

Z AI K

ssca Prfssranadua Sch f ManagmnUnvrs Pura Maaysa

Da

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DELTON

hereby decare ha he hesis is based n my rigina rk ecep fr quainsand ciains hich hae been duy acknedged s decare ha i has nbeen preiusy r cncurreny submied fr any her degree a M r herinsiuins

Mahdhir bduah

Dae: 3 1 Ju 2001

ix

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TABLE OF CONTENTS

age

BSTRT 11

BSTRK IVKNOWLEDGENTS V

PPRO V vDELRTON

LST OF TBLES xLST OF FGES

LST OF BBEVTONS/OTTONS/GLOSSRY OF TERMS V

CHAPTER TRODUTON 1 11 1 nduin 1 . 1

1 2 Backgund f he Sudy 1 3 1 3  Kuaa Lump Sck Exchange mpsie ndex 1 81 4 Kuaa Lump Sck Exchange mpsie ndex Fuues 1 .9 

na1 5 Devepmen f Deivaives Make in Maaysia 1 1 51 6 Pbem Saemen 1201 7 Signicance f he Sudy 1221 8 Reseach Obecives 1.23

1 Hypheses 1 24110 Summay 1 25

LTERTURE REVW 2 12 1 Revie f Theeica Sudies 2 122 Lieaue Revie n he LeadLag Reainship Beeen he 27

Fuues and he Sp Makes

DESRT STTSTS 3 1

V

3 1 nducin 3 1

3 2 The Kuaa Lumpu Sck Exchange mpsie ndex 3 3 3 . 3   The Kuaa Lumpu Sck Exchange mpsie ndex Fuues 3  5  

nac34 Basis35 Summay

DTA THODOLOGY41 Samping42 Daa ecin43 Mehd f naysis

431 Tes f Sainaiy4 3 2 Tes f uceain43 3 eain nasis

x

3 1 13 1 7

4. 1

4. 1

4.3  

4.4 

4.4 

4.6 

4.8 

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V

VI 

434 Muiple Regression

RESULS AND DISCUSSION

525.3 

4

Test for Sationariyes or uocorrelaionCorreaion naysisMuipe Regression naysis5.4.1  Subperiod 1 (From 15h December 1995 o 30lh Jue

4243

5.44 

97)Subperiod 2 (From 1sl Juy 1997 o 30th Sepember 1998)ubperiod 3 (Fro l October 998 o 3 December2000)Whoe Period (From 1h December 1995 o 31lDecember 000)

Summary o Resuts

CLUSI6 Summary62 Limitations o e Sudy63 Fuure Researc

REFREES/BIBLIOGRPHYNES E UOR

' X

4.9 

5.15.3 

5.45656

5.8

3

66.6.767

R.B

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LIST OF TABLES

Table age

l LOFFE Tuve FKL Fuues ns numbe f cncs) 1 6

2 Mke Demgpy FL Fuues nc 1 8

3 1 Descipive Siscs SE 3 4 

3 2 Descipive Siscs: LSE ' s nnuised eus 3 .4 

3 . 3   Descipve Siscs Sp-mnh FL n 3 6

3 4 Descipive Siscs Sp-mnh FL s nnuised eus 3 . 7  

3 . 5   Descipive Siscs Sp-mnh FL's Vume 3 8

3 6 Descipive Siscs Sp-mnh FL s Open nees 3 .9 

3 .7  Descipive Siscs Bsis 3 1 3  

4 1 LOFFEs Tue by Vume egised by he Types f 43 Fuues ncs m 1 5 2000

5 1 ugmened DickeyFue DF) esus f e Leve Tem 5 2

5 2 ugmened Dickey-Fue DF) esus f he Fis-Dieence 5 .3  

5 3   ein eciens: KLSE nd FKL 5 5

54  egessin Oupu: Subpeid 1 ( 1 5  Decembe 1 5 30  June 5 717)

5 5  egessin Oupu: Subpeid 2 ( 1 Juy 17 30  Sepembe 5 .9  

18)

5 6 egessin Oupu: Subpeid 3 ( 1 Ocbe 18 3 1 Decembe 5 1 22000)

5 7    egessin Oupu Whe peid ( 1 5  Decembe 15 31 5 4December 000

6 1 Summy f esus 63 

x

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LIST OF FIGUS

Figure age

1 1 Ta Tuver fFKL Fuures nrac m 1 995 2000 1 1 7

1 2 Daiy Prices f Spmnh FKL and KLSE 1 9952000 1 2 1

3 1 Price and Vume f SpMnh FL Fuures nrac m 3 21 995 2000

3 2 Vume and Open neres f Spmnh FKL Fuures nrac 3 1 0 m 1995 2000

3 . 3   Basis m 15 December 1995 31 December 2000 3 1 2

3 4 Basis m 1 5

December 1 995 30

June 1997 3 1 43 5 Basis m 1 Juy 1 997 30 Sepember 1998 3 1 5

3 6 Basis frm 1 Ocber 1998 31s December 2000 3 . 1 6  

4 1 DurbinWasn d Tes Decisin Rues 48

iii

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LIST OF ABBREVIATIONSNOTATIONS/GLOSSARY OF TERMS

DF

OX

PO

D

EM

EPF

FKL

FTSE 100

KBT

KLE

KLO

KLOFFE

KLSE

KLSE

H

EX

 

NYFE

P

 MS

ugmened Dickey-Fuer

hicag Mercanie Echange

mmdiy and Mneary Echange f Maayia

rude Pam Oi

D Jne nduria erage

Errr rrecin Mehd

Empyee Priden Fund

Kuaa Lumpur Sck Echange mpie nde Fuure nrac

Financia Time Sck Echange 1 00

Kana iy Bard f Trade

Kuaa Lumpur mmdiy Echange

Kuaa Lumpur Inerbank Oer ae

Kuaa Lumpur Opn d Financia Fuure Echange

Kuaa Lumpur Sck Echange

Kuaa Lumpur Sck Echange mpie nde

Maayian Deriaie earing Hue

Maayia Deriaie Echange Bhd

Maayian Fuure earing rprain

Maayian Mneary Echange

Ne Yrk Fuure Echange

Permdaan Nana Berhad

 eearch niue fnemen nay MaayiaSecuriie mmiin

v

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1 2

nveo o hede he o dvee oven n h oc pce nveo who

have psn n he soc mare may shr se he sc nde ures cnrac n

ancpan f a prce decne n he sc mare s a reu any sse due he

decne n he sc mare be se by he pr made n he ures mare

Sc nde ures have as been used as a by nvesrs mae prs

baed on he prce mvemens n boh he oc and he ue mre Becaue

f s ncn as a hedn prce mvemens n he ures mare mus have

a rn pae n rean o he mvemen n he c prces Ohere he use

f ure conrac o hede any pobe prce decne e neecve In

addn sc nde ures s as used by arbraeurs mae pr frm prce

dscrepances beeen he mare vaue and he far vaue f he ures cnra

nsequeny arbrae cve w brn he mre vue o be equa o he

cnracs far vaue hus w crrec he msprcn fhe sc nde ures

Wh recen nrducn f such ne nanca nsrumen many ssues

need be epred The rd dervaves' e s name ecause he vaue f he

dervave nsrumen derved frm he vaue f he underyn asse In he case

o he Kua Lupu Soc chne opoe nde ue conc (

he underyn nrumen he ae f ne hundred scs n he Kuaa Lumpur

Sc chane mpoe Inde (KLS I) Therefre heoecay he prce f

FI and KLSE I shud mve n andem h each her The emprca ssue s

heher h comovemen s oberved n pracce especay n ess nsunay

deveped cunry e Maaysa The reaonshp eeen he ure mre and

he underyn sp mare s f neres many researcher In h udy he

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iue ha need be addreed i he reainhip beeen he price mvemen in

he ure and he c mare Specicay hi udy acerain he ead and

ag reainhip beeen FKL and i underying inrmen he KLSE

n recen year Maayia ha increaed i er iberaie he nancia

ecr and mae Kuaa umpur a he regina nancia cenre a reu a

number f ne nancia innvain have been inrduced in he Maayian capia

marke namey he ck nde ure he hre nancia cenre ecuriie

brring and ending and he c inde pin Furhermre Maayian

capia mare i epecing a fe mre nancia prduc uch a he pin n

individua c and he Syariah nde ure Rapid devepmen f he

Maayian capia mare pen ind f ppruniy fr reearch paricuary

in he area f nancia derivaive

1.2 Background of he Sudy

The inrducin f he Kuaa Lumpur Sc Echange mpie nde

Fuure cnrac (FKL creae a ne arena in equiy rading in Maayia

nver n have he avenue hedge heir c mare piin and have he

aeaive frmuae heir prfi raegie uing c inde ure

hugh he main ncin f c inde ure i fr hedging hi nancia

derivaive inrmen i a ued fr pecuain and arbiraging Specuar

rade ck inde ure ae advanage f he price mvemen in he mare

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l.4

based n heir precnceived epecains ab he direcin f he mare Sc

inde res prvides a cheap ye highy-everaged ay specae is cheap

becase he brerage fees are reaivey cmpared he cmmissins n

individa scs and he raders d n have pay he cnrac vae in n

erms f he brerage fees raders are charged 60 per cnrac r 120 per

rnd rip This is eqivaen ab 0. 1 percen 0. 2 percen f he cnrac

vae reaivey cheaper as cmpared he cmmissins n individa sc f

0.75 percen per ransacin r 1 5 percen per rnd rip Secndy raders are

reqired pay ny a sma amn f pn capia nn as iniia margin

sar rading sc inde res s eecive m 2 Janary 2001 he iniia

margin reqiremen is 4000 per cnrac f a rader shr ses ne FKL

cnrac n 1 March 2001 a 695 .2 and bys bac he cnrac n 20 March 2001

a 6644 he rader maes a grss pr f 300 [6952-6644)

3080] His ne pr d be 2960 3080-120 = 2960]

Frm his eercise he enjys a ne re f 74 percen [2960 / 4000

0.74]. The abve eampe shs ha he sc inde res is a highy everaged

nancia insrmen here sma price changes in he sc inde res can

generae hge prs Lasy, sc inde res cnrac is sed by arbiragers

mae prs based n prce discrepancies beeen he mare vae and he fair

vae f he res cnrac

ccrding he hery he res price shd mve simanesy ih

he sc inde herise arbirage pprniies i eis This cnempranes

reainship is re in perfecy ecien mares here nfrmain and mare

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.5

sentiments eing iscounte immeiatey into the tues an the stoc pices The

issue is whethe such contempoaneous comovement of pices in oth maets is

oseve in eaity hen an inomaton comes into the maet, it is pocesse

an iscounte into the stoc pices an the tues pices If the inomation is

processe at ieent spee in iffeent maets, then the pice changes in one

maret may e faste than in the othe maet In a moe technica tem, pice

iscovey taes pace in the maet that pocesses the infomation faste an this

maet is sai to ea the othe maet Pevious stuies one y othes have

shown that tues maet tens to ea the spot maet in most cases Hest,

McComac an West (187) pefome a stuy on Vaue ine Inex tues an

S&P 500 tues with espect to thei uneying stoc inices, an foun that the

stoc inex tues pices tn to ea those of thei cash inices Kawae, Koch

an Koch (187) foun that the tues pices ea the cash pices fo etween

twenty an foy-ve minutes Thee ae stuies that oseve feeac eects

om the spot maet to the tues maet Sto an Whaey (10) concue that

the tues maet eas the cash inex y ve minutes, sometimes up to ten

minutes ut this eationship is not uniiectiona

Matiainen, Peunen an Putonen (15) suggeste that the pice

eaeship om the tues maet to the spot maet ae ue to thee easons

namey the inequent tang of the coponent stocs within the inex the ow

tansaction costs to tae tues conta, an ess estctive sho-seing in the

tues maet This stuy aso aesses the thee easons aove as the possie

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6

causs that inunc th la an lag lationship twn FKI tus an th

KSE CI Th laoation of th aov asons is iscuss low

1) Te inequent ading /the component stocks within the KSE CI

Th KSE CI consists of on hun stocs list on th Kuala umpu Stoc 

Exchang (KSE) Th inx is caculat as on th capitalisationwight

mtho which mans th stoc pic is multipli y th num of outstaning

shas an thn avag to gt th inx valu It must not that not all th

on hn componnt stocs of KSE C a ta simanosy at any point

of tim Som stocs may ct to th nw infomation immiatly, som may

ta long tim, an som may not ct at l Fuhmo, with th

capitalisation-wight mtho, th pic movmnt of lagly capitalis stocs

tns to gatly inunc th changs in th inx pic Similaly small

capitalis stocs o no hav gat impacts on th pic movmnt of th stoc 

inx Th stoc inx tus, on th oth han acts to nw infomation

immiatly sinc uying an sling tus contact a on in a pacag

Maning to say, whn uying th F contact, th uy is pchasing a contact

that consists of on hun componnt stocs of KSE CI Du to inqunt

taing ofth KSE C componnt stocs, it is anticipat that th stoc inx will

ct to nw infomation slow than th inx tus Hnc, th inx tus

pic tns to la th spot stoc inx

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7

2) Lower ansaction costs and capital requirement to trade in the tures

market

In the tues maket the bokeage ee and commission is 60 e contact o

20 e ound-ti . his is equivaent to about 0 . ecent to 0 2 ecent o the

contact vaue e ound-ti. he tansaction cost is eativey owe than the

tansaction costs to buy o se stocks in the stock market which aveage aound

075 ecent o the tnsction vaue. ecuse o ow tnsction costs in the

tues maket it is easie o investos to tde the tues contact. ence

investos wi eact to new sentiments by tading in the tues maket as a esut

the tues ice wi eect to new inomation aste than the sot rice

heeoe tues ice is beieved to ead the sot ice due to owe tansaction

costs in the tues maket In addition investos do not have to ay the

amount o the contact vaue to tade tues hey ony have to ay an initia

magin o 4000 as eective om nd anuay 2001) and have to to u any

daiy osses though the mak-to-maket rocess. his sma caita equiement

aso omotes ineensive ading in the tues maket Both ow tansaction costs

and sma caita equiement make tading in the tues maket cheae than

tading in the sot maket cause the tues maket to ocess new inomation

aste and thus induce the tues rice to move eaie thn the sot ice.

3 No short selng resictions in the futures market

Unike the stock maket the tues maket aows shot-seing activities. hat

means investos can se the tues conta athough they do not hod it. Without

any estrictions on short seing tues maket shoud be moe iquid than the sot

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1 8

maket esecially duing te beais eiod. Due to ige liuidity te tues

maket ocesses inomaton aste tan te sot maket ten te initial ice

movement sould take lace in te tues maket

e tee actos discussed above ae among te most ominent actos tat

elain wy tues maket is eected to lead te sot maket. In Malaysia stock

inde tues is still at an inancy stage wit te bit o te uala Lumu Stock

Ecange omosite Inde tues contact (FLI) came about in Decembe 1 995.

Wit te ecentness o te stock inde tues in an emeging maket contet tis

is an inteesting eseac issue to be addessed. e net section discusses te

backgound and te caacteistics o te uala Lumu Stock Ecange

omosite Inde (LSE ) te undelying asset o FLI.

1.3 Kuala Lumpur Sock Exchange Composie Index

e uala Lumu Stock Ecange omosite Inde (LSE I) is a

caitalisation· weigted inde comising o one unded stocks listed on te uala

Lumu Stock Ecange (LSE). Since it was intoduced in 196 tis nde as

been widely used as a esentation o te stock makt eomance in Malaysia

and is also eeed as te bencmak nde is basket o stocks is eviewed

consistently and te selection o te LSE Is constituent stocks is eomed

occasionally accoding to te citeia set ot by te ecange is is to ensue

te inde eects te genea economic eomance o te county s at 6

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19

Novembe 2000 1 ecent o LSE Is comonent stocks ae eesented by

ve sectos namey te tading and sevices secto 2 ecent) te industia

oducts 16 ecent) te nance secto 13 ecent) te oety and

deveoment secto 12 ecent) and te consume oducts 12 ecent) Te

emaining 19 ecent o te inde is comised o stocks om si ote sectos.

e ist o LSE Is constituent stocks is attaced in Aendi A. e

comosition o te LSE I may cange ove time uon eview by LSE based

on te ecanges seection citeia.

1. 4 Kuala Lumpur Sock Exchange Composie Index Fuures Conrac

Te uaa Lumu Stock Ecange omosite Inde tues contact

FI) is te st nancia deivatves oduct intoduced in Maaysia Tis euity

tues contact is a binding ageement between te buye and te see to deive

ad to take deivey o te basket o LSE I comonent saes at a stiuated

ice at a desinated date in te tue Te nden nsten o FLI

te 100 comonent stocks o te uaa Lumu Stock Ecange omosite Inde

LSE I). Since LSE I comises o one unded stocks acceting and taking

deivey is a dicut and costy ocess Tus nstead o te devey o te basket

o stocks tat make u te inde te stock inde tues contact is cas setted

Unde tis settement ocess tee is no ysica deivey o te undeying asset

Instead on te ast day o tading te dieence between te vaue o te tues

contact and te ast seement ce s detemned I te ode o te contact

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makes a prot he wi receive cash and i he incurs osses he wi have to pay

cash equivaent to the amount o the losses. For eampe an investor buys one

FI contract on 1 March 2001 at 695.2 points and coses out his position on 20

March 2001 at 6644 points When he purchases the tures contract he needs to

pay an initia margin o M4000 as a good aith money. he decine in the FI

price by 30.80 points causes hi to ose M3080 [308 M or M3200 net

-M3080-M20]. hrough the cash settement process he needs to pay

M3080 to cove his osses and to bing the account baance back to the initia

margin eve Whie hoding the contract or twenty days any daiy gains are

credited to the investor's margin account and any osses have to be topped up by

putting cash into his margin account his daiy settement process is known as

mark-to-market

FI is traded on the Maaysia Derivatives Echange Bhd EX)

ormery known as OFFE) a whoy-owned subsidiary o SE. his stock

inde tures contra has our contract months namey the spot month the net

month and the net two caendar quartery months he caendar quartery months

are Mch une September and December. Each contract epires on the ast

trading day o the contract mont and any open position is cash setted by 930

a.m on the day oowing the contracts nal trading day. his eans that

investors may not hod the tures contracts indenitey because the epiy dates

are specied. he contract specications o the FI tures contract is appended

in Appendi B or reerences.