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Derivatives, Volatility and Price Discovery

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  • Cohen, Benjamin H

Abstract

It is sometimes suggested that trading in derivatives leads to excessive volatility in underlying asset prices relative to what would be called for by fundamental values. These effects are tested by comparing the variances of price changes over different time horizons before and after the start of organized derivatives trading. It is found that ratios of the variances of multi-day and daily price movements decline for bond prices in the United States and Germany and for stock indices in the US, Japan and the UK, though no such effect is found for Japanese bonds. Other indicators confirm that serial correlation has tended to decline since the introduction of derivatives. While these results offer strong grounds for rejecting predictions of the destabilizing effects of derivatives, an alternative view, that derivatives accelerate the price-discovery functions of cash markets, cannot be definitively confirmed, given ambiguous breakpoint results and the many other contemporaneous developments in financial technology. Copyright 1999 by Blackwell Publishers Ltd.

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  • Cohen, Benjamin H, 1999. "Derivatives, Volatility and Price Discovery," International Finance, Wiley Blackwell, vol. 2(2), pages 167-202, July.
  • Handle: RePEc:bla:intfin:v:2:y:1999:i:2:p:167-202
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    Cited by:

    1. Chiara Oldani, 2005. "An Overview of the Literature about Derivatives," Macroeconomics 0504004, EconWPA.
    2. Martin T. Bohl & Jeanne Diesteldorf & Christian A. Salm & Bernd Wilfling, 2016. "Spot Market Volatility and Futures Trading: The Pitfalls of Using a Dummy Variable Approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(1), pages 30-45, January.
    3. Alain Chaboud & Steven Weinberg, 2002. "Foreign exchange markets in the 1990s: intraday market volatility and the growth of electronic trading," BIS Papers chapters,in: Bank for International Settlements (ed.), Market functioning and central bank policy, volume 12, pages 138-147 Bank for International Settlements.
    4. Geyser, Mariette & Cutts, Michela, 2007. "SAFEX maize price volatility scrutinised," Agrekon, Agricultural Economics Association of South Africa (AEASA), vol. 46(3), September.
    5. Adrián F. Rossignolo & Víctor A. Álvarez, 2015. "Has the Basel Committee Got it Right? Evidence from Commodity Positions in Turmoil," Remef - The Mexican Journal of Economics and Finance, Instituto Mexicano de Ejecutivos de Finanzas. Remef, March.

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