An Empirical Analysis of Lead-Lag Relationship among Various Financial Markets

The efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient", i.e. all relevant information will be fully and immediately reflected in a security's market price. Other researchers however, have disputed the efficient-market hypothesis both empirically and theoretically. In this paper, we contribute to the discussions of market efficiency by empirically testing the lead-lag relationship among various financial markets. If markets are efficient in processing information, we expect to see a simultaneous movement of various security markets and vice versa. We focus on the index level of three major security markets: the stock market, the derivative market and the fixed income market and conduct two different analyses. First, using daily data, we investigate the general lead-lag relationship of various security markets; second, after introducing an exogenous information shock (FED announcement) to the system, we examine the responses of various security markets. Our overall findings suggest that all three major financial markets (equity, fixed income and derivative) are closely correlated with each other. However, we do see some level of lead-lag relationships among our variables and thus provide certain evidences against the efficient market hypothesis. Our results will offer insights towards a better understanding about how quickly different security markets process and reflect information thus benefit investors who wish to profit from the arbitrage opportunities.