Testing the Stabilization Hypothesis in the UK Short-Term Interest Rates: Evidence from a Garch-X Model

Posted: 1 May 2005

See all articles by Sotiris K. Staikouras

Sotiris K. Staikouras

City University - Cass Business School; ALBA Graduate Business School

Abstract

The objective of this paper is to examine the validity of one of the recurring arguments made against futures markets that they give rise to price instability. The paper concentrates on the impact of futures trading on the spot market volatility of short-term interest rates. The analytical framework employed is based on a new statistical approach aiming to reconcile the traditional models of short-term interest rates and the conditional volatility processes. More specifically, this class of models aims to capture the dynamics of short-term interest rate volatility by allowing volatility to depend on both scale effects and information shocks. Using a GARCH-X and asymmetric GARCH-X model four main conclusions emerge from the present study. First, the empirical results suggest that there is an indisputable change in the nature of volatility with evidence of mean reversion after the onset of futures trading. Second, the information flow into the market has improved as a result of futures trading. Third, a stabilization effect has been detected running from the futures market to the cash market by lowering volatility levels and decreasing the risk in the spot market. Finally, trying to capture the leverage effect the findings suggest that positive shocks have a greater impact on volatility than negative shocks.

Keywords: Short-term interest rates, Futures trading, Volatility, GARCH-X modeling.

JEL Classification: C22, G14, G15

Suggested Citation

Staikouras, Sotiris, Testing the Stabilization Hypothesis in the UK Short-Term Interest Rates: Evidence from a Garch-X Model. The Quarterly Review of Economics and Finance, Vol. 46, pp.169-189, 2006, Available at SSRN: https://ssrn.com/abstract=709084

Sotiris Staikouras (Contact Author)

City University - Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

ALBA Graduate Business School ( email )

Athinas Ave. & 2A Areos Str.
Vouliagmeni 166 71, Athens
Greece

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