Price discovery and volatility spillover between interest rate cash and futures market in India

The current study analyses the Interest rate futures market in India in terms of its evolution as well as pricing efficiency. It attempts to study the spillover effect and determines if there exists a lead-lag relationship between spot and futures markets of Treasury Bonds in India. For this, we conduct causality and spillover tests on daily data of cash and futures prices of 8.40 GS 2024 to measure the relationship between these. These tests bring out that futures market is leading the cash market and the yield of the underlying security has impact on the future settlement price. The two markets show a bidirectional volatility spill over. There is a lack of persistence and hence volatility shocks are insignificant in both the markets. Overall, we conclude that there exists a low volume in the IRF market. This indicates that policy makers must take adequate steps to make these markets deep and highly efficient for information coming back from futures to cash market, which can spur further growth of this segment. A step towards this can be strengthening of fixed income capital markets to ensure higher participation from domestic as well as foreign investors.