Derivatives and Asset Price Volatility: A Test Using Variance Ratios

28 Pages Posted: 13 Dec 2005

See all articles by Benjamin H. Cohen

Benjamin H. Cohen

Bank for International Settlements (BIS)

Date Written: January 1996

Abstract

The implications of the presence of derivative instruments for price movements in underlying financial markets are tested by comparing the variances of price changes over different time horizons before and after the start of organised derivatives trading. It is found that ratios of the variances of multi-day and daily price movements decline for bond prices and stock indices in the United States and Germany, though no such effect is found for Japanese bonds. For the stock indices, the post-derivatives variance ratios are statistically indistinguishable from those that would be characteristic of a random walk, though this is not found to be the case for the bonds. This is interpreted to mean that derivatives accelerate the incorporation of new information into asset prices.

Suggested Citation

Cohen, Benjamin H., Derivatives and Asset Price Volatility: A Test Using Variance Ratios (January 1996). BIS Working Paper No. 33, Available at SSRN: https://ssrn.com/abstract=861724 or http://dx.doi.org/10.2139/ssrn.861724

Benjamin H. Cohen (Contact Author)

Bank for International Settlements (BIS) ( email )

Basel
Switzerland