The Introduction of Derivatives on the Dow Jones Industrial Average and Their Impact on the Volatility of Component Stocks

This article examines the impact of trading in the Dow Jones Industrial Average (DJIA) index futures and futures options on the conditional volatility of component stocks. It investigates the contention that the introduction of futures and futures options on the DJIA could increase volatility in the 30 stocks comprising the DJIA. The conditional volatility of intraday returns for each stock before and after the introduction of derivatives is estimated with the Generalized Autoregressive Conditional Heteroscedasticity (GARCH) model. Estimated parameters of conditional volatility in prefutures and postfutures periods are then compared to determine if the estimated parameters have changed significantly after the introduction of the various derivatives. The results suggest that the introduction of index futures and futures options on the DJIA has produced no structural changes in the conditional volatility of component stocks. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21: 633–653, 2001     

Do individual index futures investors destabilize the underlying spot market?

This study investigates the impact of introducing index futures trading on the volatility of the underlying stock market. We exploit a unique institutional setting in which presumably uninformed individuals are the dominant trader type in the futures markets. This enables us to investigate the destabilization hypothesis more accurately than previous studies do and to provide evidence for or against the influence of individuals trading in index futures on spot market volatility. To overcome econometric shortcomings of the existing literature we employ a Markov‐switching‐GARCH approach to endogenously identify distinct volatility regimes. Our empirical evidence for Poland suggests that the introduction of index futures trading does not destabilize the spot market. This finding is robust across three stock market indices and is corroborated by further analysis of a control group. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:81–101, 2011     

Option‐Expiration Effects in Small Markets: The Spanish Stock Exchange

This study analyzes the effect of the expiration of the Ibex‐35 Index derivatives, as well as the first four stock options traded in the Spanish Equity Derivatives Exchange, on the return, conditional volatility, and trading volume of the underlying assets. The analysis covers the period from the introduction of the various derivatives to December 1995. This period has been divided into two subperiods in order to determine if there are changes in the conclusions. The expiration of the Ibex‐35 index derivatives is associated with an increase in the trading volume of the underlying asset, but it has no significant effect on either the underlying asset prices or on the level of volatility on the expiration day. However, the expiration of the stock options has significant impact on their underlying assets. We observed a downward pressure on prices and a reduction of volatility level in the week before the expiration date and a significant increase in trading volume on the expiration day. The absence of futures contracts on individual stocks, among other possible causes, may explain these differences. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:905–928, 2001     

Does Index Futures Trading Reduce Volatility in the Chinese Stock Market? A Panel Data Evaluation Approach

This study investigates the effect of introducing index futures trading on the spot price volatility in the Chinese stock market. We employ a recently developed panel data policy evaluation approach (Hsiao, Ching, and Wan, 2011) to construct counterfactuals of the spot market volatility, based mainly on cross‐sectional correlations between the Chinese and international stock markets. This new method does not need to specify a particular regression or a time‐series model for the volatility process around the introduction date of index futures trading, and thus avoids the potential omitted variable bias caused by uncontrolled market factors in the existing literature. Our results provide empirical evidence that the introduction of index futures trading significantly reduces the volatility of the Chinese stock market, which is robust to different model selection criteria and various prediction approaches. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:1167–1190, 2013     

The Volatility Behavior and Dependence Structure of Commodity Futures and Stocks

This study finds substantial risk diversification potential between certain commodity groups and stocks by exploring the dependence between their patterns of regime switching. None of the commodity groups share a common volatility regime with stocks, nor are the regime‐switching patterns of grains, industrials, metals, or softs, dependent on that of stocks. Simultaneous volatile regimes of commodity futures and stocks tend to be infrequent and short‐lived. In addition, in spite of financial contagion, animal products, grains, and softs typically demonstrate very low correlations with stocks even in simultaneous volatile regimes. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 34:93–101, 2014     

Volatility spillover effects and cross hedging in corn and crude oil futures

Using a volatility spillover model, we find evidence of significant spillovers from crude oil prices to corn cash and futures prices, and that these spillover effects are time‐varying. Results reveal that corn markets have become much more connected to crude oil markets after the introduction of the Energy Policy Act of 2005. Furthermore, when the ethanol–gasoline consumption ratio exceeds a critical level, crude oil prices transmit positive volatility spillovers into corn prices and movements in corn prices are more energy‐driven. Based on this strong volatility link between crude oil and corn prices, a new cross‐hedging strategy for managing corn price risk using oil futures is examined and its performance is studied. Results show that this cross‐hedging strategy provides only slightly better hedging performance compared with traditional hedging in corn futures markets alone. The implication is that hedging corn price risk in corn futures markets alone can still provide relatively satisfactory performance in the biofuel era. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark     

Expiration‐day effects on individual stocks and the overall market: Evidence from Taiwan

On expiration days of the MSCI‐TW index futures, the Taiwan spot market is associated with abnormally large volume and high index volatility, along with mild index reversal. The effects concentrate only in the last five minutes of expiration days and appear to be strengthened by the adoption a call auction closing procedure by the Taiwan Stock Exchange. Individual index stocks show high volatility and strong tendency of price reversal, with large‐ and small‐cap stocks being affected more than the medium‐sized stocks. The highest‐weighted stocks exhibit excessive volume and volatility, which is disproportionate to the impact on all other index stocks, indicating that the expiration‐day effects may have been amplified by the attempt of price manipulation using large‐cap stocks. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:920–945, 2009     

Pricing efficiency of the S&P 500 index market: Evidence from the Standard & Poor's Depositary Receipts

Standard & Poor's Depositary Receipts (SPDRs) are exchange traded securities representing a portfolio of S&P 500 stocks. They allow investors to track the spot portfolio and better engage in index arbitrage. We tested the impact of the introduction of SPDRs on the efficiency of the S&P 500 index market. Ex‐post pricing efficiency and ex‐ante arbitrage profit between SPDRs and futures were also examined. We found an improved efficiency in the S&P 500 index market after the start of SPDRs trading. Specifically, the frequency and length of lower boundary violations have declined since SPDRs began trading. This result is consistent with the hypothesis that SPDRs facilitate short arbitrage by simplifying the process of shorting the cash index against futures. Tests of pricing efficiency comparing SPDRs and futures suggested that index arbitrage using SPDRs as a substitute for program trading in general results in losses. Although short arbitrages earn a small profit on average, gains are statistically insignificant. A trade‐by‐trade investigation showed that prices are instantaneously corrected after the presence of mispricing signals, introducing substantial risk in arbitraging. Evidence in general supported pricing efficiency between SPDRs and the S&P 500 index futures—both ex‐post and ex‐ante. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:877–900, 2002     

Memory in returns and volatilities of futures' contracts

Various authors claim to have found evidence of stochastic long‐memory behavior in futures’ contract returns using the Hurst statistic. This paper reexamines futures’ returns for evidence of persistent behavior using a biased‐corrected version of the Hurst statistic, a nonparametric spectral test, and a spectral‐regression estimate of the long‐memory parameter. Results based on these new methods provide no evidence for persistent behavior in futures’ returns. However, they provide overwhelming evidence of long‐memory behavior for the volatility of futures’ returns. This finding adds to the emerging literature on persistent volatility in financial markets and suggests the use of new methods of forecasting volatility, assessing risk, and optimizing portfolios in futures’ markets. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:525–543, 2000     

Market microstructure effects on volatility at the TAIFEX

This study examines whether changes in the frequency of market clearing or changes in trading hours on competing exchanges that use different auction systems affect the volatility of futures prices. In particular, this study exploits a natural experiment in the frequency of market clearing of stock index futures contracts traded on the Taiwan Futures Exchange (TAIFEX) to assess whether successive increases in the frequency of market clearing are associated with changes in the volatility of futures prices. The impact of changes in the trading hours on the TAIFEX and on the competing Singapore Exchange (SGX) where a similar Taiwanese stock index futures contract trades under a continuous auction market regime is also examined. The evidence for the impact of an increase in the frequency of market clearing on volatility is mixed. However, the introduction of simultaneous opening times for the TAIFEX (which batches orders at the open) and the SGX (which does not) is associated with a significant reduction in the volatility in SGX Taiwanese stock index futures prices. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:1219–1243, 2007     

Efficiency of the IBEX spot–futures basis: The impact of the mini‐futures

This paper considers whether the introduction of the mini‐futures contract for the Spanish Ibex index affects overall market efficiency. Using linear, non‐linear, and fractional integration modeling techniques for the basis term, results of this study suggest the following salient points. First, the equilibrium speed of adjustment is reduced after the introduction of the mini‐futures contract. This effect is particularly pronounced in the mini‐futures second year when its contracts are more heavily traded. Second, fractional integration tests support longer memory in the basis term after the contract introduction, again particularly in the second year. Third, the relationship between the full‐size and mini‐futures contracts appears highly efficient, with a quick speed of adjustment and short memory. Finally, an examination of the volatility dynamics suggests that in the second year of the mini‐futures contract shocks to spot return volatility exhibit longer memory. The results reported here suggest that the increased use of the mini‐futures contract after its introduction has had a detrimental impact on price discovery. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28: 398–415, 2008     

Options on bond futures: Isolating the risk premium

The introduction of unspanned sources of risk (and frictions) implies that option prices include a risk premium. Prima facie evidence of the existence of risk premia in option prices is contained in the implied volatility smile patterns reported in the literature. This article isolates the risk premium (defined as the simple difference between estimated and observed option prices) on options on U.K. Gilts, German Bunds, and U.S. Treasury bond futures using models that include price jumps and stochastic volatility. This study finds that single and multi‐factor stochastic volatility models with jumps may explain the empirical regularities observed in bond futures. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:169–215, 2003     

Information revelation in the futures market: Evidence from single stock futures

This paper analyzes 31 months of data on 137 single‐stock futures (SSFs) traded on OneChicago. The results indicate that on the days they trade, SSFs contribute approximately 24% of the price discovery for underlying stocks. Information revelation in the SSFs market decreases with the ratio of spreads in the futures and the stock markets and the volatility in the stock market. Moreover, the quality of the market for the underlying stocks improves substantially after the introduction of the SSFs market, with the largest improvement occurring on days with SSFs trading. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:335– 353, 2008     

Stock index futures trading and volatility in international equity markets

This article examines stock market volatility before and after the introduction of equity‐index futures trading in twenty‐five countries, using various models that account for asynchronous data, conditional heteroskedasticity, asymmetric volatility responses, and the joint dynamics of each country's index with the world‐market portfolio. We found that futures trading is related to an increase in conditional volatility in the United States and Japan, but in nearly every other country, we found either no significant effect or a volatility‐dampening effect. This result appears to be robust to model specification and is corroborated by further analysis of the relationship between volatility, trading volume, and open interest in stock futures. An increase in conditional covariance between country‐specific and world returns at the time of futures listing is also documented. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:661–685, 2000     

Asymmetric covariance in spot‐futures markets

This article studies how the spot‐futures conditional covariance matrix responds to positive and negative innovations. The main results of the article are achieved by obtaining the Volatility Impulse Response Function (VIRF) for asymmetric multivariate GARCH structures, extending Lin (1997) findings for symmetric GARCH models. This theoretical result is general and can be applied to analyze covariance dynamics in any financial system. After testing how multivariate GARCH models clean up volatility asymmetries, the Asymmetric VIRF is computed for the Spanish stock index IBEX‐35 and its futures contract. The empirical results indicate that the spot‐futures variance system is more sensitive to negative than positive shocks, and that spot volatility shocks have much more impact on futures volatility than vice versa. Additionally, evidence is obtained showing that optimal hedge ratios are insensitive to the well‐known asymmetric volatility behavior in stock markets. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:1019–1046, 2003     

The Disappearing January/Turn of the Year Effect: Evidence From Stock Index Futures and Cash Markets

This study examines the returns, relative to the S&P 500, on cash indices and futures tracking smaller stocks around the turn of the year. While we control for volatility clustering, return autocorrelation in small stock indices, and other calendar effects, our main focus is the evolution of the turn of the year effect through time: in particular, whether the effect is smaller or takes place earlier subsequent to the introduction of the S&P Midcap and Russell 2000 futures in 1993. We find that evidence of a traditional turn of the year effect, in both cash and futures, is confined to the pre‐1993 period. Post‐1993, there are no abnormal returns during the turn of the year window as a whole. Interestingly, returns in this period remain high on the last trading day of December, but they are negative across the first five trading days of January. In addition, post‐1993, we often observe significant abnormal returns prior to the traditional turn of the year, i.e., in the pre‐Christmas and post‐Christmas windows. Taken together, our results suggest that market participants may be eliminating the turn of the year effect with the aid of two new futures contracts that are well suited to this purpose. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:755–784, 2004     

Examining futures price changes and volatility on the trading day after a limit‐lock day

This paper examines the effect that price limits have on futures prices by testing what happens to price changes and volatility on the trading day following a limit‐lock day. The results show evidence that prices continue to rise on average the day after an up‐limit day. In addition, limits appear to influence price volatility for some but not all of the futures contracts. However, since the findings vary across the different commodity futures contracts, it is likely that limits do not directly impact price volatility. © 2000 John Wiley & Sons, Inc. Jrl Fut Mark 20:445–466, 2000     

What moves the gold market?

In this article, we provide a detailed characterization of the intraday return volatility in gold futures contracts traded on the COMEX division of the New York Mercantile Exchange. The approach allows the study of intraday patterns, interday ARCH effects, and announcement effects in a coherent framework. We show that the intraday patterns exert a profound impact on the dynamics of return volatility. Among the 23 U.S. macroeconomic announcements, we identify employment reports, gross domestic product, consumer price index, and personal income as having the greatest impact. Finally, by appropriately filtering out the intraday patterns, we find that the high‐frequency returns reveal long‐memory volatility dependencies in the gold market, which have important implications on the pricing of long‐term gold options and the determination of optimal hedge ratios. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:257–278, 2001     

Pricing Eurodollar Futures Options with the Heath—Jarrow—Morton Model

This article uses the algorithm developed by Ritchken and Sankarasubramanian (1995) to make comparisons among the Heath—Jarrow—Morton (HJM) models (Heath, Jarrow, & Morton, 1992) with different volatility structures in pricing the Eurodollar futures options. We show that the differences among the HJM models as well as the difference between the HJM models and Black's model can be insignificant when the volatility of the forward rate is relatively small. Moreover, our findings imply that the difference between the American‐style and European‐style options is insignificant for options with a life of less than 1 year. However, the difference can be significant for options with a 1‐year maturity, the difference depending on the exercise price. Finally, our tests indicate that the difference between the forward price and the futures price is insignificant if the volatility parameter is low enough and when the volatility of the spot rate is proportional to the spot rate. A higher volatility parameter can lead to a significant difference between the forward price and the futures price, although its impact on the price of the options will still be trivial. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21: 655–680, 2001     

Volume and Volatility Surrounding Quarterly Redesignation of the Lead S&P 500 Futures Contract

During the last weeks before each quarterly expiration of Standard & Poor's (S&P) 500 futures, the bulk of trading volume begins to shift away from the next‐to‐expire (nearby or lead) contract toward the second‐to‐expire (next out) contract. At some point, the exchange formally redesignates the next out as the new lead contract, and the next out replaces the nearby in the futures pit location designated for the lead contract. This event invariably results in a dramatic increase (decrease) in trading activity in the next out (nearby) contract. This shift in relative trading volumes is due to the microstructure of the futures exchange rather than new information or underlying volatility conditions. The event thus offers us an opportunity to examine how volatility responds to noninformation‐based exogenous changes in volume. This study examines the volatility behavior of nearby and next out S&P 500 futures contracts on the 10 days surrounding quarterly redesignation of the lead contract. Our model measures possible changes in (a) the level of volatility and/or (b) the association between volume and volatility after redesignation of the lead contract. Results indicate that when we account for the association between volume and volatility, the higher volume lead contract consistently experiences a lower level of volatility. This outcome supports the view that the larger population of liquidity providers who trade the more active lead contract fosters greater market depth and lower volatility. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:1119–1149, 2001