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Derivatives and asset price volatility: a test using variance ratios

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  • Benjamin H. Cohen

    (International Monetary Fund (IMF))

Abstract

The implications of the presence of derivative instruments for price movements in underlying financial markets are tested by comparing the variances of price changes over different time horizons before and after the start of organised derivatives trading. It is found that ratios of the variances of multi-day and daily price movements decline for bond prices and stock indices in the United States and Germany, though no such effect is found for Japanese bonds. For the stock indices, the post-derivatives variance ratios are statistically indistinguishable from those that would be characteristic of a random walk, though this is not found to be the case for the bonds. This is interpreted to mean that derivatives accelerate the incorporation of new information into asset prices.

Suggested Citation

  • Benjamin H. Cohen, 1996. "Derivatives and asset price volatility: a test using variance ratios," BIS Working Papers 33, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:33
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    References listed on IDEAS

    as
    1. John Y. Campbell & N. Gregory Mankiw, 1987. "Are Output Fluctuations Transitory?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(4), pages 857-880.
    2. Gary A. Bortz, 1984. "Does the treasury bond futures market destabilize the treasury bond cash market?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 4(1), pages 25-38, March.
    3. B. Wade Brorsen, 1991. "Futures trading, transaction costs, and stock market volatility," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 11(2), pages 153-163, April.
    4. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
    5. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-1237, December.
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    Cited by:

    1. Jürgen Von Hagen & Ingo Fender, 1998. "Central Bank Policy in a More Perfect Financial System," Open Economies Review, Springer, vol. 9(1), pages 493-532, January.

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