Efficiency tests of the UK financial futures markets and the impact of electronic trading systems

Abstract

This paper undertakes tests for market efficiency of three UK financial futures contracts: FTSE100 futures (stock index futures), Long Gilt (bond futures), Short Sterling (interest rate futures) and also examines the impact of the introduction of electronic trading system on their market efficiency. The analysis is based on the notion of weak-form informational efficiency of the Efficient Market Hypothesis (EMH). For robustness, the study employs three test methods, ADF unit root test, KPSS test and Lo & MacKinlay Variance Ratio test, to investigate the randomness of the futures price fluctuation, which generally signifies market efficiency. Any evidence of market weak-form inefficiency implies that the futures prices do not follow a random walk process and the past price of the financial instrument can be used to forecast the futures price to obtain superior profit. The results show that the three markets under investigation are weak-form informational efficient. Before the introduction of electronic trading system, the UK bond futures market is relatively the most efficient among the three markets under investigation. After automation, the efficiency of FTSE100 futures contract improves to become the most efficient among the three markets under investigation.

Acknowledgements

The author would like to thank Dr Mike Buckle at the School of Business and Economics, University of Wales Swansea for his useful comments.

Notes

¹ For example, S&P 500 futures returns by Goldenberg (1988, 1989), Cheung and Ng (1990), Fung et al . (1994); interest rate futures returns by Neftci and Policano (1990), Piccinato et al . (1998), Lee and Mathur (1999); spot equity returns by Hasbrouck and Ho (1987), Stoll (1989), Madhavan et al . (1997), Lin et al . (1999) and foreign exchange returns by Goodhart and Figliuoli (1991), Goodhart and Guigale (1993), Goodhart et al . (1996), Low and Muthuswamy (1996).