The Impact of Single Stock Futures on Market Efficiency and Volatility: A Dynamic CAPM Approach

ABSTRACT

The concerns regarding regulations of futures markets and their destabilizing ability are unresolved in both developed and developing markets. Following stringent regulations of single stock futures (SSFs) for resumption episode after financial crises, this study addresses this concern and investigates the destabilizing impact of SSFs on the underlying stocks in an emerging economy using data of companies listed in the Karachi Stock Exchange between 1999 and 2008. Specifically, the study explores whether SSFs have caused a simultaneous increase in the volatility and operational efficiency of their underlying spot market counterparts. The results reported in the study show that the introduction of SSFs has no significant impact on market efficiency and volatility of SSFs underlying stocks and non-SSFs stocks. The results affirm that SSFs have, at least, no destabilizing impact on the underlying stocks.

KEY WORDS:

• CAPM
• GED
• GJR-GARCH
• SSFs

Notes

^1. De Bandt and Hartmann (2000), Krugman (2003), Wolf (1999), etc.

^2. IMF (2002), Dodd (2000), Kregel (1998) and Garber (1998).

^3. Differences in regulations for resumed SSFs from initially issued SSFs’ contracts back in 2001. (1) Increase in bank or cash margin from 50% to 100% to make trading in SSFs controlled, (2) applicability of concentration margin instead of special margin, and (3) retaining of the mark to market profit with regulated exchange instead of distributing it to stakeholders.

^4. There are several advantages of using of SSFs over future index. McKenzie, Brailsford, and Faff (2001) affirm this by stating that it is difficult to find out the exact impact of introduction of futures markets using stock index data, because stock index represent the whole market, and it is not possible to identify the true effect in the constituent stocks. Also, the index cannot be traded directly. So, the impact of futures on market efficiency and volatility would be more visible in the individual stocks. Indeed, it is easier to apply stringent trading rules on SSFs than index, in case any undesirable impact is observed in any stock trading. SSFs market with distinguishing features lends itself to address different issues, not previously discussed. For example, unlike stock index, the SSFs have different introduction dates, apart from their ability to study the impacts induced by the introduction of futures. So, this makes it possible to observe the significance of these characteristics on the impact of their introduction. Secondly, by doing so, it is possible to check the change in the dynamics of a control sample to avoid endogeneity bias, which is not possible in case of index futures. This helps in drawing robust conclusions regarding the matter. Under such circumstances, it is inevitable to investigate the impact of the introduction of SSFs on the underlying market’s dynamics, and whether changes in regulatory framework are necessary.

^5. Bollerslev (1987), Baillie and Bollerslev (2002), Kaiser (1996), and Beine, Laurent, and Lecourt (2002), suggested the use of Student’s t distribution. However, Nelson (1991) and Kaiser (1996) recommend GED for such an instance, on hand.

^6. The foreign portfolio investors injected around $404 million in the KSE in the year 2013, according to National Clearing Company of Pakistan (NCCPL).

^7. Wall Street Journal, “Daring Investors Brave Pakistan Market,” Jan. 3, 2014.

^8. 17 SSFs-Commercial Banks, 5 SSFs-Cement, 4 SSFs-Refinery, 3 SSFs each for Fertilizer, Oil & Gas Exploration, Oil & Gas Marketing and Power Generation & Distribution, 2 SSFs each for Technology & Communication and Synthetic & Rayon and 1 SSF each for Textile, Transport and Insurance.

^9. Following studies have used similar or lesser sample size: Malik and Shah (2014), Ullah and Shah (2013), Malik, Shah, and Khan (2013), Jamal and Fraz (2013), Awan and Rafique (2013), Malik and Khan (2012), Siddiqi et al. (2012), Khan, Shah, and Abbas (2011), Khan (2006), Debasish (2009), Mazouz and Bowe (2006), and McKenzie, Brailsford, and Faff (2001).

^10. The SSFs are Askari Commercial Bank Limited (ACBL), Bank of Punjab (BOP), D G Khan Cement Co. Ltd (DGKC), Dewan Salman Fibres Limited (DSFL), Engro Chemical Limited (ECL), Faysal Bank Limited (FABL), Fauji Fertilizer Company (FFC), Hub Power Company Limited (HUBC), Ibrahim Fibres Limited (IBFL), Karachi Electric Supply Corporation (KESC), Lucky Cement Limited (LUCK), Muslim Commercial Bank Limited (MCB), Maple Leaf Cement Factory Limited (MLCF), National Bank of Pakistan (NBP), Nishat Mills Limited (NML), Pakistan International Airlines (PIA), Pioneer Cement Limited (PIOC), Pakistan Oilfields Limited (POL), Pakistan State Oil Company Limited (PSO), Pakistan Telecommunication Limited (PTCL), Sui Northern Gas Pipelines Limited (SNGPL), Sui Southern Gas Company Limited (SSGC) and Telecard Limited (TELE).

^11. The Non-SSFs are Bank Al Habib Limited (BKHB01), Bank Al Habib (BKHB06), Cherat Cement Co. Limited (CHERAT), CRESCENT, Dawood Hercules Textile Limited (DAWOOD), Fector Cement Limited (FECTO), Garton Company Limited (GARTON), Habib Metropolitan Bank Limited (HMBL), Karachi Electric Limited (KEL01), Karachi Electric Limited (KEL06), Kohat Cement Limited (KOHAT), Mari Gas Company Limited (MARI), Pakistan Data Limited (PKDATA01), Pakistan Data Limited (PKDATA04), Pakistan National Shipping Corporation (PNSC), SECPL, SEL, Shell Company Limited (SHELL), Silk Bank Limited (SILKBANK), Soneri Bank Limited (SONERI), Sui Southern Gas Company Limited (SSGC), and Telecard Company Limited (TELE).

^12. Results for Non-SSFs could be obtained from the corresponding author through email.