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We reconsider the issue of price discovery in spot and futures markets. We use a threshold error correction model to allow for arbitrage operations to have an impact on the return dynamics. We estimate the model using quote midpoints, and we modify the model to account for time-varying transaction costs. We find that the futures market leads in the process of price discovery. The lead of the futures market is more pronounced in the presence of arbitrage signals. Thus, when the deviation between the spot and the futures market is large, the spot market tends to adjust to the futures market.
Recent empirical research suggests that measures of investor sentiment have predictive power for future stock returns at intermediate and long horizons. Given that sentiment indicators are widely published, smart investors should exploit the information conveyed by the indicator and thus trigger an immediate market response to the publication of the sentiment indicator. The present paper is the first to empirically analyze whether this immediate response can be identified in the data. We use survey-based sentiment indicators from two countries (Germany and the US). Consistent with previous research we find predictability at intermediate horizons. However, the predictability in the US largely disappears after 1994. Using event study methodology we find that the publication of sentiment indicators affects market returns. The sign of this immediate response is the same as the sign of the intermediate horizon predictability. This is consistent with sentiment being related to mispricing but is inconsistent with the sentiment indicator providing information about future expected returns.
JEL-Classification: G12, G14