Relationships between Chinese stock market and its index futures market: Evaluating the impact of QFII scheme

The purpose of this study is to examine the impact of the Qualified Foreign Institutional Investors (QFII) on the dynamic relationship between the Chinese stock index futures and spot markets. The research uses high frequency data (5 min interval) and various dynamic methods including VECM, GJR, BEKK and DCC GARCH models to evaluate price discovery and volatility spillover effect. The data used is from 01/02/2011 to 29/07/2011, which includes 3 months before and after the implementation of the QFII scheme to trade in the Chinese stock index futures market. We find a bi-directional asymmetric lead-lag relationship between the Chinese stock index futures and spot markets, indicating a significant lead from the futures market to the spot market but weak lead from the spot market to the futures market in terms of both magnitude and lasting time. It is observed that the introduction of the QFII has enhanced the price discovery role of the futures market and increased the predictive power of the futures market. Our empirical results show that the Chinese stock index futures market has become less volatile (risky) and probably more efficient after the introduction of QFII. We find that foreign institutional investors could enhance the volatility spillover effect from the futures market to the spot market, indicating an improvement in information transmission running from the futures to spot markets. Our results suggest that Chinese government should continue opening its financial markets to the world. The dynamic conditional correlation between the futures and spot markets decreases and becomes more volatile after the introduction of QFII. This indicates that the futures and spot markets become less correlated after the QFII event which may have major influence on hedging strategies.