Impacts of Derivative Markets on Spot Market Volatility and Their Persistence

Abstract

In this article, I investigate the impacts of futures and options markets on the volatility of the underlying market with a focus on their persistence over time. Empirical study yields several interesting results that often contrast with previous findings. it suggests that the impacts on the spot market volatility depends on the quality of new information generated by derivatives trading. Futures market reduces spot market volatility by providing new, material information, but options market generates noisy information which results in increase in volatility and decrease in its sensitivity to price change. While the impact by futures persists, that of options mostly disappears as the market matures. This is perhaps because futures market is mainly driven by informed, experienced participants, while options market attracts new, inexperienced investors. It would be worth revisiting other markets with the methods in this study and testing validity of the conclusions made in previous studies.