We reconsider the issue of price discovery in spot and futures markets. We use a threshold error correction model to allow for arbitrage opportunities 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 a) the futures market leads in the process of price discovery and that b) the presence of arbitrage opportunities has a strong impact on the dynamics of the price discovery process.
price discovery futures markets threshold error correction common factor weights