Does an Index Futures Split Enhance Trading Activity and Hedging Effectiveness of the Futures Contract?

Journal of Futures Markets, Vol. 26, 2006

Posted: 22 Aug 2006

See all articles by Lars L. Norden

Lars L. Norden

Stockholm University - Stockholm Business School

Abstract

Recently, several stock index futures exchanges have experimented with an altered contract design in order to make the contract more attractive and to increase investor accessibility. In 1998, the Swedish futures exchange (OM) split the OMX-index futures contract with a factor 4:1, without altering any other aspect of the futures contract design. This isolated contract redesign enables a ceteris paribus analysis of the effects of a futures split. The purpose is to investigate whether the futures split affects the futures market trading activity, as well as hedging effectiveness and basis risk of the futures contract. A bivariate GARCH framework is used to jointly model stock index returns and changes in the futures basis, and to obtain measures of hedging efficiency and basis risk. Significantly increased hedging efficiency and lower relative basis risk is found following the split. Also, evidence of an increased trading volume is found after the split, whereas the futures bid-ask spread appears to be unaffected by the split. The results are consistent with the idea that the futures split has enhanced trading activity and hedging effectiveness of the futures contract, without raising the costs of transacting at the futures market.

Suggested Citation

Nordén, Lars L., Does an Index Futures Split Enhance Trading Activity and Hedging Effectiveness of the Futures Contract?. Journal of Futures Markets, Vol. 26, 2006. Available at SSRN: https://ssrn.com/abstract=925807

Lars L. Nordén (Contact Author)

Stockholm University - Stockholm Business School ( email )

Sweden

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