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Spot Market Volatility and Futures Trading: The Pitfalls of Using a Dummy Variable Approach
Author(s) -
Bohl Martin T.,
Diesteldorf Jeanne,
Salm Christian A.,
Wilfling Bernd
Publication year - 2016
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/fut.21723
Subject(s) - economics , futures contract , volatility (finance) , econometrics , financial economics , futures market , spot market , volatility smile , stock market index , autoregressive conditional heteroskedasticity , stock market , markov chain , spot contract , computer science , electricity , paleontology , horse , machine learning , electrical engineering , biology , engineering
This study challenges the existing literature examining the impact of the introduction of index futures trading on the volatility of its underlying. To overcome econometric shortcomings of previously published work using the dummy variable approach, we employ a Markov‐switching‐GARCH technique. This approach endogenously identifies distinct volatility regimes rather than modeling an exogenously defined one‐step change in the volatility process. We investigate stock market volatility in France, Germany, Japan, the United Kingdom, and the United States. Our empirical results indicate that index futures trading does neither stabilize nor destabilize the underlying spot market. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 36:30–45, 2016