| Abstract: | This article examines empirically the dynamic relationship between spot market volatility, futures trading, and options trading in the context of a trivariate simultaneous equations model. The empirical analysis provides strong evidence that significant simultaneity, in addition to feedback, characterizes the relationship between the proxy for time-varying spot market volatility and derivative trading. Also, futures trading and options trading are found to affect spot market volatility in opposite directions in the structural model proposed. The results, corroborated by Monte Carlo evidence, suggest that the failure to account for any contemporaneous interaction between the variables under consideration, as well as the omission of any of the two derivatives trading activities examined in this study, may generate serious misspecification and ultimately produce misleading estimation results and statistical inference. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 245–270, 1999 |
