The Role of Futures Trading in Spot Market Fluctuations: Perpetrator of Volatility or Victim of Regret?
Posted: 27 Aug 2001
We examine the role of index futures trading in spot market volatility. We use the exponential generalized auto-regressive conditional heteroskedasticity (EGARCH) approach to measure volatility, analyze causality and feedback relations between volatilities in the spot and futures markets, and test various hypotheses in the context of a multivariate model that incorporates other macrostate variables. Our empirical results suggest index futures trading may not be blamed for the observed volatility in the spot market. Rather, we find stronger and more consistent support for the alternative posture that volatility in the futures market is an outgrowth of a turbulent cash market. We use the regret (cognitive dissonance) theory to explain our results.
Keywords: futures trading, spot market volatility, exponential GARCH, regret theory
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