Price Discovery and Foreign Participation in Korea's Government Bond Futures and Cash Markets

This paper examines the impact of foreign participation in Korean Treasury Bond (KTB) futures and its role in price discovery, using daily transactions data from the over-the-counter market and from the Korea Exchange for the futures. Our analysis suggests that foreign trading in the KTB futures market leads the price discovery process for the underlying bonds. Empirical results show that foreigners’ daily net long positions in the futures market exert significant influence in KTB and KTB futures prices. We also find that it is the unexpected component of foreign investors’ net long futures positions that explains a significant share of the pricing effects. Our empirical results also suggest that information transmission between cash and futures markets has improved significantly in the crisis and post-crisis period while local market participants have become better in extracting information content from market transactions.