Effect of Equity Index Futures Trading on Stock Market Volatility: Evidence from China

Abstract

This paper investigates the effect of equity index futures trading on stock market volatility and provides the empirical evidence from the Chinese market. GARCH model variations are applied to analyze the change in conditional volatility of the underlying equity index after the introduction of futures trading. Both additive and multiplicative effects are considered in the GARCH study. Multiple market factors are also considered to control for other possible causes of volatility. The Stock-Watson “counterfactual VAR” method is adopted to decompose the source of volatility change. The evidence indicates that the introduction of CSI300 index futures trading does not significantly affect the conditional volatility of the underlying index. This finding is robust to different model specifications. The Stock-Watson test shows that there is no structural change following the introduction of futures trading. The only difference comes from the decreasing innovation variances.