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The temporal relationship between derivatives trading and spot market volatility in the U.K.: Empirical analysis and Monte Carlo evidence
Author(s) -
Kyriacou Kyriacos,
Sarno Lucio
Publication year - 1999
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/(sici)1096-9934(199905)19:3<245::aid-fut1>3.0.co;2-j
Subject(s) - futures contract , econometrics , economics , volatility (finance) , spot market , spot contract , monte carlo method , proxy (statistics) , financial economics , derivatives market , mathematics , statistics , electricity , electrical engineering , engineering
This article examines empirically the dynamic relationship between spot market volatility, futures trading, and options trading in the context of a trivariate simultaneous equations model. The empirical analysis provides strong evidence that significant simultaneity, in addition to feedback, characterizes the relationship between the proxy for time‐varying spot market volatility and derivative trading. Also, futures trading and options trading are found to affect spot market volatility in opposite directions in the structural model proposed. The results, corroborated by Monte Carlo evidence, suggest that the failure to account for any contemporaneous interaction between the variables under consideration, as well as the omission of any of the two derivatives trading activities examined in this study, may generate serious misspecification and ultimately produce misleading estimation results and statistical inference. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 245–270, 1999