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The Effect Of Futures Trading Activity On The Distribution Of Spot Market Returns

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Author Info

  • Juan A. Lafuente

    ()
    (Universitat Jaume I)

  • Manuel Illueca Muñoz

    (Universitat Jaume I)

Abstract

There is extensive empirical research on the potential destabilizing effects of futures trading activity on spot market volatility. Rather than just focussing on spot volatility, this paper deals with the contemporaneous relationship between futures trading volume and the overall probability distribution of spot market returns. To disentangle the potential destabilizing effect of futures trading activity from cross-interactions due to price discovery process, futures volume is broken down into two drivers: expected and unexpected trading activity. Then, a non-parametric approach is used to estimate the density function of spot return conditional to both spot and futures trading volume. Empirical evidence using intraday data from the Spanish stock index futures market over the period 2000-2002 is provided. Our empirical findings can be summarized as follows: i) spot market volatility is positively related to spot trading volume, ii) for any given spot trading volume, a significant and positive relationship between unexpected futures trading activity and spot volatility is detected; however no significant relationship arises when expected futures trading volume is considered. These findings are consistent with theoretical models predicting that futures trading activity is not a force behind irrational spot price fluctuations. Existe abundante evidencia empírica en la literatura acerca de la potencial transmisión de volatilidad desde los mercados de futuros hacia el correspondiente mercado subyacente. Para contrastar la existencia de una potencial desestabilización desde el mercado de derivados, en este trabajo se propone un enfoque más general apartir del análisis de la relación entre el volumen negociado en el mercado de futuros y la toda la distribución de probabilidad de la rentabilidad del subyacente. Para diferenciar la potencial desestabilización de las interacciones derivadas del procesode formación de precios, se descompone el volumen negociado en sus componentes esperada y no esperada. A partir de esta descomposición, se lleva a cabo una estimación no paramétrica de la función de densidad de la rentabilidad del subyacente condicional al volumen negociado, tanto en el mercado de contado comoen el mercado de futuros. Sobre la base del nuevo enfoque propuesto, se proporciona evidencia empírica para el mercado español de futuros sobre el Ibex 35 a lo largo del periodo 2000-2002. La evidencia empírica detectada pone de manifiesto dos aspectos relevantes: a) la volatilidad del mercado de contado está positivamente correlacionada con el volumen de negociación en dicho mercado y b) dado un nivel de negociación en el mercado de contado, se observa una relación positiva entre la negociación inesperada en el mercado de derivados y la volatilidad del mercado de contado. Estos dos aspectos no son coherentes con la idea de que el mercado de futuros es una fuente de desestabilización para el mercado de contado.

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File URL: http://www.ivie.es/downloads/docs/wpasec/wpasec-2003-23.pdf
File Function: Fisrt version / Primera version, 2003
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Bibliographic Info

Paper provided by Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) in its series Working Papers. Serie EC with number 2003-23.

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Length: 25 pages
Date of creation: Nov 2003
Date of revision:
Publication status: Published by Ivie
Handle: RePEc:ivi:wpasec:2003-23

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Keywords: Mercados de Futuros; Transmisión de volatilidad; Estimación kernel Futures markets; Volatility transmission; Kernel smoothing;

References

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  1. Taylor, Nick & Dijk, Dick van & Franses, Philip Hans & Lucas, Andre, 2000. "SETS, arbitrage activity, and stock price dynamics," Journal of Banking & Finance, Elsevier, vol. 24(8), pages 1289-1306, August.
  2. Campbell, John Y & Grossman, Sanford J & Wang, Jiang, 1993. "Trading Volume and Serial Correlation in Stock Returns," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 905-39, November.
  3. A. Craig MacKinlay, Krishna Ramaswamy, 1988. "Index-Futures Arbitrage and the Behavior of Stock Index Futures Prices," Review of Financial Studies, Society for Financial Studies, vol. 1(2), pages 137-158.
  4. Dwyer, Gerald P, Jr & Locke, Peter R & Yu, Wei, 1996. "Index Arbitrage and Nonlinear Dynamics between the S&P 500 Futures and Cash," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 301-32.
  5. John Board & Gleb Sandmann & Charles Sutcliffe, 2001. "The Effect of Futures Market Volume on Spot Market Volatility," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(7&8), pages 799-819.
  6. Stein, Jeremy C., 1987. "Informational Externalities and Welfare-Reducing Speculation," Scholarly Articles 3660740, Harvard University Department of Economics.
  7. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-37, December.
  8. Miller, Merton H & Muthuswamy, Jayaram & Whaley, Robert E, 1994. " Mean Reversion of Standard & Poor's 500 Index Basis Changes: Arbitrage-Induced or Statistical Illusion?," Journal of Finance, American Finance Association, vol. 49(2), pages 479-513, June.
  9. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
  10. Tse, Yiuman, 2001. "Index arbitrage with heterogeneous investors: A smooth transition error correction analysis," Journal of Banking & Finance, Elsevier, vol. 25(10), pages 1829-1855, October.
  11. Karpoff, Jonathan M., 1987. "The Relation between Price Changes and Trading Volume: A Survey," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(01), pages 109-126, March.
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Cited by:
  1. Hakim, A. & McAleer, M.J., 2009. "VaR Forecast and Dynamic Conditional Correlations for Spot and Futures Returns on Stocks and Bonds," Econometric Institute Research Papers EI 2009-32, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  2. M. Illueca & J. Lafuente, 2008. "Introducing the mini-futures contract on Ibex 35: implications for price discovery and volatility transmission," Spanish Economic Review, Springer, vol. 10(3), pages 197-219, September.

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