Volatility Discovery across Interlinked Securities

Abstract

Where does new volatility enter the volatility of securities listed in many countries? While literature has focused on where information enters the price, I develop a framework to study how each market’s volatility contributes to the permanent volatility of the Asset. I build a VECM with an Autoregressive Stochastic Volatility (ASV) framework estimated using the MCMC method and Bayesian inference. This specification allows defining the measures of a market’s contribution to volatility discovery. In the application, I study cash and 3-months futures markets of some metals traded on the London Metals Exchange. I also study the EURO STOXX 50 Index and its futures. I find that for most the securities, while price discovery happens on the cash market, the volatility discovery mostly happens in the futures market. Overall, the results suggest that information discovery and volatility discovery do not necessarily have the same determinants.

Keywords: Multivariate Stochastic Volatility, Monte Carlo Markov Chain, Futures markets

JEL Classification: C32, C58, G14