Index Futures Trading, Information and Stock Market Volatility: The Case of Greece

Abstract

The debate on the impact of futures on stock market volatility is still controversial. In other words, the issue of whether the futures markets affect underlying spot markets is not widely accepted. Some past critics of index futures agree that the introduction of stock index futures increases stock market volatility. Others report no significant volatility effect associated with the introduction of stock index futures. In general, the link between futures trading and stock market volatility has become very complex. Several studies have empirically examined the long-term relationship across the decades. Most of them compare the volatility of the spot market before and after the introduction of futures trading, using econometric models. According to Bologna and Cavallo,¹ there are two theories in the literature about the relationship between futures markets and underlying spot markets. The first theory supports the argument that futures trading destabilises the underlying spot market by increasing its volatility. In practice, volatility increases through speculation or arbitrage strategies. Then, an increase in interest rates and the cost of capital, leading to a reduction in the value of investments, is quite possible. From a financial viewpoint, the price volatility usually depends on the arrival of new information in the market. If the market is efficient, the price reflects this new information, but the literature presents arguments that futures markets increase market depth² and reduce spot market volatility.

Practical applications

The introduction of a futures market and, in particular, the impact of futures on stock market volatility is a long debate. Previous studies show that the futures market leads to an increase in market depth and a decrease in volatility. This is due to the more rapid rate at which information is reflected in prices and speculation. Other studies suggest that a decrease in cash market volatility is due to an increase in market liquidity. Empirical studies for UK and US financial markets do not conclude clearly whether the introduction of futures stabilises or destabilises the underlying spot market. It is therefore important for practitioners to look at the link between information (news) and volatility. To the authors’ knowledge, this is the first study that examines this effect of the Greek futures market on stock market volatility.

This paper examines the effect of futures trading on the volatility of the underlying spot market. It focuses on various techniques to investigate the relationship between information and the volatility of the FTSE/ASE-20 and FTSE/ASE Mid 40 indices in Greece. The results for the FTSE/ASE-20 index suggest that futures trading has led to decreased stock market volatility (negative effect), but the results for the FTSE/ASE Mid 40 index indicate that the introduction of stock index futures has led to increased volatility (positive effect), while the estimations of the unconditional variances indicate lower market volatility after the introduction of stock index futures. Furthermore, the results show that good news has a more rapidly impact on FTSE/ASE-20 stock return volatility. For the FTSE/ASE Mid 40 index, the results suggest that news is reflected in prices more slowly, while old news has a less persistent effect on prices. These findings are helpful to financial managers dealing with Greek stock index futures.