Do Index Futures Cause Spot Market Volatility? An Investigation of the Australian Resources Index

Abstract

This paper applies GARCH models to ascertain the impact of index futures trading on the volatility of the spot market. Specifically, the research aims to determine whether the introduction of index futures trading increases or decreases the level of volatility within the underlying spot market. In addition, the research verifies the sensitivity of price to information as well as the impact the leverage effect may have on the degree and structure of volatility. As Australia is a commodity driven economy, resources constitute one of the largest economic sectors. Following from this, the daily closing price of the ASX 200 Resources Index for the period 2010 to 2016 was therefore used in the analysis. Given that 14 October 2013 was when the Australian Securities Exchange launched the ASX 200 Resources Index futures, investigating the volatility prior to and after this date is also a focus of the paper. The results of the study suggest that the introduction of index futures did not substantially increase the level of volatility in the spot market but found that there is an increase in sensitivity to historical information; and that a negative leverage effect exists within the Resources Index. Since the Australian share market operates within a dynamic financial landscape, the study adopts a framework that seeks to provide behavioural and macroeconomic explanations for the findings, where appropriate.