Abstract
This paper investigates possible spillover effects on the spot market due to the initiation of derivatives markets. Although speculation, which is apparent because of the low transaction cost of derivatives markets, produces noise in the financial system, the speculative forces and the rational hedging strategies jointly contribute to the price discovery process. Furthermore, the demand and supply forces are responsible for the financial system equilibrium and high volatility regimes imply high rates for the accumulation of new information. According to many analysts, there still exists a puzzle regarding the stabilization or destabilization effect of Futures contracts’ onset, which is both country and model specific. For that reason, this paper examines empirically the case of three European countries by the application not only of conventional structural break analysis, but also of regime shift analysis in order to account for the timing of possible spillover effects, and hence, to overcome the conflicting results of the extant literature. Furthermore, the proposed econometric methodology considers some stylized financial facts such as the leverage effect, the time varying risk premium, the decomposition of the day of the week effect, the leptokurtosis and the skewness of the returns’ distributions. For the purposes of our analysis we use data from the UK, Spain and Greek capital markets and according to the empirical findings, there exists a significant stabilization effect, which is negatively associated with the level of efficiency and completeness of the capital markets examined. However, in some cases there exists a short run destabilization effect for 1 or 2 months.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
Black (1976) relates the asymmetric effects of negative news to the fact that a negative price change increases the leverage ratio of a firm, and thus increases the risk of the firm. Furthermore, the leverage effect is directly linked with the financial behaviour of economic units; a risk averse investor has a curved utility function where a marginal decrease is higher than a marginal increase, implying that the volatility is increased in response to bad news and decreased in response to good news asymmetrically. The response of volatility to news is asymmetric, since the bad news effect is higher, in absolute terms, than the good news effect.
In this framework we consider both the ‘skewness’ in the information flow in the volatility specification (leverage effect) and in the return’s distribution.
Campbell and Hamao (1989) argues that this is a common fact in most financial data with no implication in the efficiency of the underlying markets.
Its dynamics are based on the Box-Cox transformation, and embodies many ARCH specifications as special cases; the leverage effect is captured by positive values of the parameter ‘γ’.
Glosten et al. (1989), considered the ARCH-L model which captures the leverage effect.
It is worth mentioning that in the case of the FTSE-20 index, parameterizations that allow for market effect in the conditional mean equation result in left asymmetry, which is revealed by the fact that this regressor is negatively skewed.
As shown by the corresponding AIC and the diagnostic statistics on the residuals of the models.
In the case of the FTSE-20 index the results regarding skewness rolling estimators are opposite when the mean market effect is omitted from the mean equation.
References
Antoniou A, Holmes P (1995) Futures trading, information and spot price volatility: evidence from the FTSE 100 stock index futures contract using GARCH. J Bank Finance 19:117–129. doi:10.1016/0378-4266(94)00059-C
Antoniou A, Holmes P, Priestley R (1998) The effects of stock index futures trading on stock index volatility: an analysis of the asymmetric response of volatility to news. J Futures Mark 18(2):151–166. doi:10.1002/(SICI)1096-9934(199804)18:2<151:AID-FUT2>3.0.CO;2-1
Bansal VK, Pruitt SW, Wei KCJ (1989) An empirical re-examination of the impact of CBOE option initiation on the volatility and trading volume of the underlying equities: 1973–86’. Financ Rev 24:19–29. doi:10.1111/j.1540-6288.1989.tb00328.x
Bessembinder H, Seguin PJ (1992) Futures-trading activity and stock price volatility. J Finance 47(5):2015–2034. doi:10.2307/2329008
Black F (1976) Studies of stock market volatility changes. In: Proceedings of the American statistical association, business and economic statistics section, pp 177–181
Bollerslev T (1986) Generalized autoregressive conditional heteroskedasticity. J Econom 31:307–327. doi:10.1016/0304-4076(86)90063-1
Bologna P, Cavallo L (2002) Does the introduction of index futures effectively reduce stock market volatility? Is the futures effect immediate? Evidence from the Italian stock exchange using GARCH. Appl Financ Econ 12(3):183–192. doi:10.1080/09603100110088085
Butterworth D (2000) The impact of futures trading on underlying stock market volatility: the case of the FTSE Mid 250 contract. Appl Econ Lett 7(7):439–442. doi:10.1080/135048500351131
Campbell JY, Hamao Y (1989) Predictable stock returns in the United States and Japan: a study of long-term capital market integration. Working Paper No. 3191, National Bureau of Economic Research
Chang EC, Cheng JW, Pinegar JM (1999) Does futures trading increase stock market volatility? The case of the Nikkei stock index futures markets. J Bank Finance 23(5):727–753. doi:10.1016/S0378-4266(98)00069-7
Chiang MH, Wang CY (2002) The impact of futures trading on spot index volatility: evidence for Taiwan index futures. Appl Econ Lett 9:381–385. doi:10.1080/13504850110068837
Conrad J (1989) The price effect of option introduction. J Finance 44(2):487–498. doi:10.2307/2328601
Cox C (1976) Futures trading and market information. J Polit Econ 84(6):1215–1237. doi:10.1086/260509
Dennis SA, Sim AB (1999) Share price volatility with the introduction of individual share futures on the Sydney futures exchange. Int Rev Financ Anal 8:153–163. doi:10.1016/S1057-5219(99)00013-7
Ding Z, Granger CWJ, Engle RF (1993) A long memory property of stock market returns and a new model. J Empir Finance 1:83–106. doi:10.1016/0927-5398(93)90006-D
Drimbetas E, Sariannidis N, Porfiris N (2007) The effect of derivatives trading on volatility of the underlying asset: evidence from the Greek stock market. Appl Financ Econ 17(2):139–148. doi:10.1080/09603100500461702
Edwards FR (1988a) Does futures trading increase stock market volatility. Financ Anal J 44(1):63–69. doi:10.2469/faj.v44.n1.63
Edwards FR (1988b) Futures trading and cash market volatility: stock index and interest rate futures. J Futures Mark 8:421–439. doi:10.1002/fut.3990080404
Engle RF, Ng VK (1993) Measuring and testing the impact of news on volatility. J Finance 48:1749–1778. doi:10.2307/2329066
Engle RF, Lilien DM, Robins RP (1987) Estimating time varying risk premia in the term structure: the ARCH-M model. Econometrica 55:391–407. doi:10.2307/1913242
Fama EF (1965) The behaviour of stock market prices. J Bus 38:34–105. doi:10.1086/294743
Figlewski S (1981) Futures trading and volatility in the GNMA market. J Finance 36(2):445–456. doi:10.2307/2327030
Friedman M (1953) The methodology of positive economics. In: Essays in positive economics. University of Chicago Press, Chicago
Glosten LR, Jagannathan R, Runkle D (1989) Relationship between the expected value and the volatility of the nominal excess return on stocks. Mimeo, Northwestern University, Evanston
Grossman SJ (1977) The existence of futures markets, noisy rational expectations and informational externalities. Rev Econ Stud 44(3):431–449. doi:10.2307/2296900
Gullen H, Mayhew S (2000) Stock index futures trading and volatility in international equity markets. J Futures Mark 20:661–685. doi:10.1002/1096-9934(200008)20:7<661:AID-FUT3>3.0.CO;2-R
Hamilton JD, Susmel R (1994) Autoregressive conditional heteroskedasticity and changes in regime. J Econom 64:307–333. doi:10.1016/0304-4076(94)90067-1
Hansen BE (1994) Autoregressive conditional density estimation. Int Econ Rev 35(3):705–730. doi:10.2307/2527081
Hansesn BE (1992) The likelihood ratio test under non-standard conditions: testing the Markov switching model of GNP. J Appl Econ 7:861–882
Harris L (1989) S&P 500 cash stock price volatilities. J Finance 48:1749–1778
Hicks JR (1946) Value and capital, 2nd edn. Clarendon, Oxford, pp 136–139 Chapter ix and x
Illueca M, Lafuente JA (2003) The effect of spot and futures trading on stock index market volatility: a nonparametric approach. J Futures Mark 23(9):841–858. doi:10.1002/fut.10091
Kavussanos MG, Visvikis ID, Alexakis PD (2008) The lead-lag relationship between cash and stock index futures in a new market. Eur Financ Manag 14(5):1007–1025. doi:10.1111/j.1468-036X.2007.00412.x
Keynes JM (1930) A treatise on money: the applied theory of money, vol 2. Macmillan, London, pp 142–147
Kyriacou K, Sarno L (1999) The temporal relationship between derivatives trading and spot market volatility in the U.K.: empirical analysis and Monte Carlo evidence. J Futures Mark 19(3):245–270. doi:10.1002/(SICI)1096-9934(199905)19:3<245:AID-FUT1>3.0.CO;2-J
Lambert P, Laurent S (2001) Modelling financial time series using GARCH-type models and a skewed student density. Université de Liège, Mimeo
Lamoreux CG, Lastrapes WD (1990a) Persistence in variance, structural change and the GARCH model. J Bus Econ Stat 5:121–129
Lamoreux CG, Lastrapes WD (1990b) Heteroskedasticity in stock return data: volume versus GARCH effects. J Finance 45:221–229. doi:10.2307/2328817
Lee SB, Ohk KY (1992) Stock index futures listing and structural change in time-varying volatility. J Futures Mark 12:493–509. doi:10.1002/fut.3990120502
Lien D, Quirk J (2002) Measuring the benefits from futures markets: conceptual issues’. Int J Bus Econ 1(1):53–58
Ma C, Rao R (1988) Information asymmetry and option trading. Financ Rev 23:39–51. doi:10.1111/j.1540-6288.1988.tb00773.x
Mandelbrot B (1963a) The variation of certain speculative prices. J Bus 36:394–419. doi:10.1086/294632
Mandelbrot B (1963b) New methods in statistical economics. J Polit Econ 71:421–440. doi:10.1086/258792
Mandelbrot B (1967) The variation of some other speculative prices. J Bus 40:393–413. doi:10.1086/295006
Mayhew S, Mihov V (2004) How do exchanges select stocks for option listing? J Finance LIX(1):447–471. doi:10.1111/j.1540-6261.2004.00638.x
McKenzie MD, Brailsford TJ, Faff RW (2001) New insights into the impact of the introduction of future trading on stock price volatility. J Futures Mark 21:237–255. doi:10.1002/1096-9934(200103)21:3<237:AID-FUT3>3.0.CO;2-0
Merton RC (1995) Financial innovation and the management and regulation of financial institutions. J Bank Finance 19:461–481. doi:10.1016/0378-4266(94)00133-N
Perikli A, Koutmos G (1997) Index futures and options and stock market volatility. J Futures Mark 17:957–974. doi:10.1002/(SICI)1096-9934(199712)17:8<957:AID-FUT6>3.0.CO;2-K
Pilar C, Rafael S (2002) Does derivatives trading destabilize the underlying assets? Evidence from the Spanish stock market. Appl Econ Lett 9:107–110. doi:10.1080/13504850110049441
Powers MJ (1970) Does futures trading reduce price fluctuations in the cash markets? Am Econ Rev 60:460–464
Ross SA (1976) Options and efficiency. Q J Econ 90:75–90. doi:10.2307/1886087
Ross SA (1989) Information and volatility: the no-arbitrage martingale approach to timing and resolution irrelevancy. J Finance 44:1–17. doi:10.2307/2328272
Sharpe WF (1964) Capital asset prices a theory of market equilibrium under conditions of risk. J Finance 19(3):425–442. doi:10.2307/2977928
Skinner D (1989) Options markets and stock return volatility. J Financ Econ 23:61–78. doi:10.1016/0304-405X(89)90005-6
Spyrou SI (2005) Index futures trading and spot price volatility: evidence from an emerging market. J Emerg Market Finance 4:151–167. doi:10.1177/097265270500400203
Stein J (1987) Information externalities and welfare reducing speculation. J Polit Econ 95:1123–1145. doi:10.1086/261508
Stein J (1989) Efficient capital markets, inefficient firms: a model of myopic corporate behavior. Q J Econ 104:655–669. doi:10.2307/2937861
Susmel R (2000) Switching volatility in private international equity markets. Int J Finance Econ 5:265–283. doi:10.1002/1099-1158(200010)5:4<265:AID-IJFE132>3.0.CO;2-H
Telser L (1958) Futures trading and the storage of cotton and wheat. J Polit Econ 66(3):233–255. doi:10.1086/258036
Yu SW (2001) Index futures trading and spot price volatility. Appl Econ Lett 8(3):183–186. doi:10.1080/13504850150504568
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Karathanassis, G.A., Sogiakas, V.I. Spill over effects of futures contracts initiation on the cash market: a regime shift approach. Rev Quant Finan Acc 34, 95–143 (2010). https://doi.org/10.1007/s11156-009-0149-4
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11156-009-0149-4