This paper examines empirically the dynamic relationship between spot and futures prices in stock index futures markets using data for the KOSPI 200 during 1996 to 2001, and employing nonlinear-equilibrium-correction approach that essentially is based on the extension of Markovian regime shifts to nonstationary framework. The empirical results provide strong evidence in favor of cointegrating relationship between spot and futures prices with a cointegrating vector, which implies mean reversion of the basis and is consistent with the predictions of the Cost of Carry model. Nevertheless, a linear-vector--equilibrium-correction model was rejected strongly when tested against a Markov-switching-vector-equilibrium-correction model that allowed for two regimes in the mean of equilibrium correction model, as well as in the variance-covariance matrix. The empirical model ultimately proposed therefore, is consistent with the large theoretical literature focusing on the dynamic relationship between spot and futures prices in the spirit of Cost of Carry model, as well as with the increasingly growing empirical literature stressing the existence of important nonlinearities in both spot and futures prices movements.
