The effect of derivatives trading on volatility of the underlying asset: evidence from the Greek stock market

Abstract

In this article, the effects of the introduction of the futures and options into the FTSE/ASE 20 index on the volatility of the underlying index are studied. This particular issue is quite controversial since contradictory results have been found in various markets. Analysing the data (August 1997–April 2005) with the help of an EGARCH model it is shown that the introduction of derivatives has induced a reduction of the conditional volatility of the FTSE/ASE20 index and consequently it has increased its efficiency.

Notes

¹ The EGARCH (1, 1) model is tested against a series of alternative EGARCH models by using the likelihood ratio (LR) test and in all cases the null hypothesis that the return generating process is expressed by an EGARCH (1, 1) cannot be rejected.

² For maximizing the maximum log-likelihood function, it is assumed that residuals follow the generalized error distribution, a special case of which is the normal distribution (Nelson, 1991). The Generalized distribution includes a parameter in its function regulating its tails thickness and consequently it can capture the leptokurtosis, usually appearing in the distributions of stock returns. (Fama, 1963, 1965).

³ The results of the literature are somewhat contradictory, probably due to the specific characteristics of the markets under study or to the employed method of analysis. For example, Calado et al . (2005) in their study on the Portuguese market arrived into conflicting conclusions concerning the effects of the derivatives on the market volatility.

⁴ Also the log likelihood values of the EGARCH models with the GED were much greater than those using the normal and t distributions.