THE IMPACT OF SIMEX FUTURES TRADING ON THE VOLATILITY OF THE MSCI HK INDEX

Abstract

The debate on whether stock index futures trading causes the stock markets to be more volatile has been going on for years ever since the introduction of this financial derivative instrument. Speculation in the futures and options markets have been blamed by many observers for the large volatility swings in the 1980's experienced by stocks markets in the United States. This period coincided with the introduction of futures and options trading of stock indices in the United States markets. Most researchers have been divided over this issue with some believing that futures trading of stock indices does increase the volatility in the stock markets while others hold the view that the volatility in the stock markets actually decrease after the introduction of futures trading of the stock indices. This academic exercise provides further evidence on this issue with new data from the recent introduction of the MSCI HK Index futures trading on SIMEX. Statistical tests are conducted to determine the impact of futures trading of the index on the spot index volatility. A procedure used in this study that deserves mention is the randomization test, which has only recently been used in the finance literature. The results of the tests in this study provide strong evidence that futures trading of the index has caused a decrease in the spot index volatility. Also it was found that futures prices tend to lead spot prices in reacting faster to market-wide information, indicating the efficiency of the futures markets in disseminating information over the spot markets.