cash segment

8/10/2019 Cash Segment

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The Effect of Fut res Tradin g

on Cash Market Volatil ty:Ev de ce from the Lo do Stoc Excha ge

by

Gar Robinson

B nk f ng nd L d RBAH.he v ews exp essed a e t se the aut and n t ne essar y th se

the Ban Eng and e usua d s a mer app es he auth r sg ate u t an B nd t e Ban Eng and E n m cs D v s n andPr ess r tep en hae e t e nd n Bus ness h he p

mmen s

B k f g d N 8 73003 8SSN


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Con en

A stra t 1

1 n r du n 3

Futures rad ng and Cash arketV lat l ty 6

3 A Prel m nary tat st al Analys s fk P e V lat l ty n he Un ed

K ngd m 8 3

4 dell ng P e V at l ty 14

5 C n lus ns 21

B l graphy 3

a les 2 8


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Introductio

he st k ma ket rashes n O t e 1 8 and O t e 1 8 he ped tf us a adem attent n and that f the eg at y auth r t es, n the

ss y dam g ng e f the eq ty f t es market and p rtnsure s n eat ng ex ess ash market v at ty t su r s ng y

perhaps, s me f the m st tte mp a nts ame r m eq ty ma ketmake s n the Un ted tates wh , e a se f the r gat n t q te

nt nu us es su e ed at the hands f p tf ns re s andndex ar trageu s B th pra t t ners and a adem s have a erted

regu at rs t the p ss ty that utu es markets and ther der vat vese u ty markets w att a t th n rmed trade s and r sk v ngspe u at rs wh se a t t es w u d tend t desta se the ashma kets. h s n e n has esu ted n est t ve a t n y s meregu at y a th t es n Japan r exam e t ad ng h urs have een

edu ed marg ns and mm ss n ha ges n eased, and da y em ts redu ed n an e t t nt v at ty

he et a a guments an e advan ed n s p t the n reasedde reased v at ty due t utu es t ad ng. wever, the we ght femp a ev den e suggests that at east f r U se u t es ma kets,wh e der vat ves t ad ng may have se ved t n ease extreme y sh tte m v at ty [du pa t u a y t the effe t f w t h ng h urs see

) See M e 99 )o scu s o o the co seque ces o ex t ge om ket-m ker

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St and Wha ( 87 l nger term vati it ha either rema ned

la gel una fe ted b utu e tr ading ma even have been edu e

hi paper a e e whet e ut re trading ha n u ed ex ev lat lit n the L nd n St k Ex hange (LSE) Spe f a eexam ne the effe t n ave age a v ati t n the a mar e

(mea ured f r rea n explained ater the SE Al S are n exf the FT SE F ture t aded n the L nd n nte nati na F nan a

Futu e Ex hange (L FFE). Thi i an intere ting exe e n t e f g venthe different ma ket an in t tut na tr ture in the nited K ng m(f examp e, m ket maker n the LSE are n t required t mit pr e

hange between t ran a t n ) an the e er mp rtan e p rt

in ure n the UK equit market than n the S market, and in v e the ant eviden e elating t UK finan ial ma ket .

he meth d l g p ev u e ea h in th ield ha been impr ved

up n in an imp rtant e pe t. Othe e ar he have t p a tudieduncondi t iona mea u e pri e v ati t u h a the tandard

e viati n the g pri e i fe en e mea u ed th ugh a m v ngample wind w eg war ( 88a b) St l and Whale ( 87)]. B

ntra t in t i pape it i re gni e that the mea e f v at t

app p iate t a pa ti ula inan a in trument depen up n thenature f the di t ibut i n f etu n In part ular, the ample tandard

deviat n return i app p ate if the d tr but n f eturn ha a ter ed a as a t onary no ma varia te. wever e r t marketet rn a e t pi all und t be non s a tiona ee, f examp e

Baldauf and Sant ni ( ) and evennon - no mal [ ee B l er ev (1 8 ]

The tudie f Baldau and Sant ni ( 1), Lee and Ohk (1 2) and

Ant ni u and H lme ( ) te ted f r fut re ndu ed v atil t n t e

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context o GARC models which condition current volat lity on past

vo at ity) but did not cond tion for changes n monetary reg me I

addit on, the volatility o stock returns has been found to exh bit a

asymmetr c response to news associated w th the effect of everage:bad/bear sh ews i creases volat l ty more tha does good ews [ e

B ack 1976 a d Nelson ( 99 )] Measures of vo ati i y are thereforecalculated wh ch are appropriate to a character sat o o the stoc

market retur s distr but on which ta es i to accou t these features as

appropriate

The paper is arranged as fo ows. Section 2 br e ly rev ews thetheoret ca discuss on o utures induced cash mar et vo ati ity, a d t e

empir ca ev dence ava lable ma nly relat ng to US securities mar ets

In an e ort to denti y t e like y causes o chang ng cash mar etvo atility o her han fu ures rading,Section 3 documents the per od

under review 980-9 ) wi t part cu ar reference to changes in

monetary policy regime in the United K ngdom. On the bas s o t sdiscuss o a d i view of the date on wh ch the L IF F E u tures

contracts were introduced the period of a alys s is accord ng y sub

divided A prel minary analysis a d characterisat o of stock pr cevolat lity for each sub-period is g ve Sect o 4 prese ts a AR H- M

model which allows us to in er the (ce teri paribu ) mpact of uturestrading upon stoc pr ce volatil ty on the LSE Fina ly, Sect on5 draws

some conclusions and regulatory po icy imp icat ons.

(2) In th s s udy, by con as no a ymmet i f n or e FSE Al- ha i ex.

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Futures Tra i g a Cash Market Volatility

(a) eo e cal g en s

Key t the q e ti n whethe the exi tence f t e c nt act hinc ea e ec ea e ca h p ice v a ility i the e ate q e ti n f h tkin f inve t an t a e ib att acte t the e ma ket y t eavai abi ity f ut e c nt act F examp e it ha been a g e in

pp t e ce v ati ity that the exi tence f e ivative ec itie

which a e i kie than thei n e ying ec itie an which may e h t ffe e i k ave e even i k ving inve tpp t nitie which they w p efe t inve tment in the c

ma ket C n equently the e i ve t wi e e t the ca h ma ket infav u the ut e ma ket eaving p e minant y i k ave e l ng te m inve t in the ca h ma ket, which then bec me lev latile Thi in t n att act u the i k ave e inve t wh ing

a iti nal ma ket liqui ity the e y making the ca h ma ket m e ab et ab b la ge t a e an the e e e v latile ee Detemp e anSel en (1 87) H weve thi a gument i e y a e eca e fa bit age c n it n which link e ivative p ice an n e ying ca hp ice it i i icult t ee h w p ice v atility in the e ma ket cchange in epen ent y the e i n ike y t be any v latility t an febet een the t ma ket . C n equent y we cann t evaluate the e fect

f utu e t a ing n the ca h ma et in i lati n, t m t c n i e thee ect n th the ca h ma ket an the tu e ma ket a a y temNeve the e available eq ilib ium m e have h wn that the effect

f t e t a ing n ca h ma ket v ati ity i ambig ee Kawai(1 8 ), Su b ahmanyam (1 1) an T v ky (1 8 )

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thi e ti we examine a m el whi h, e au e f a itragere t i ti , ul e n i ere t repre e t either the a h mar et rthe futu e ma et the exp iti i a exte i n f that i Cutler

P te a a Summe 1 0 ] Let there e tw la e f t a erSm t moneytra e a e their i ve tme t e i i a rati al

e a t f future etu n iti e n their n mati t at timetOt a thei ema f t k ri e i re p e t expe te ex eretu ver the i -f ee ate Thei ex e ema t ab

exp e e a

whe eRt i the etu n t the t k i exEt i theiti al expe tat pe at a the pa amete efle t the

wea th f ma t m ne t a e w the leve age availa le th ugh thefutu e ma ket an thei pee f e p e,V s t the pe eive

i equili ium EtR t+ - r . The inf rmati et t will in lu e, nteinf mati f m the i ex pti ma et whi h wi help

i ve t r i ti gui h etwee iqui it/p tf li i u a e ivetra e a t a e whi h ignif new n fu ame ta [ ee G ma

1 88

Fee b kt r er a e thei f e a t f futu e etu pa t etuThi la f i ve t in l e te hni al a al t t aria t ategi ta p tf li in u e in e ea h f the e t pe f i ve t r u an

ell t k i e p n e t pa t ma ket ha ge The e t a e m ea le aive Thei ex e ema an e exp e a :

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he e (L)i a p l n mial lag fun ti n. he demand hi h anyper eived di equ ib ium gene ate depend up n the parameter,

hi in tu n depend up n t e ea th f feedba k t ad ,wfthe rpeed f e p n ev and t e leverage avai ab e th ugh the future

ma ket

An t e a f t ade ma al be indentified index arbitrageureve it i a umed that the pla an e entia uperfi a r le i

en u ing that equi b ia in the t market are mutual tent )

Equi ib ium f thi ma ket btain hen the um f ex e demand fb th type f inve t i ze and i g ven b t e re ur i n:

he e ii i t e nn vati n in etu n , and"U ( {(L 9(.refle t market tru tu e leve age and peed f re p n e t neA uming t e inn vati n in t e t k fundamental ha a n tantva ian e t e va ian e f etu n an be n t be

0; I ]

he e 30 13"

cash segment

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