Derivatives and asset price volatility: a test using variance ratios

Benjamin Cohen

No 33, BIS Working Papers from Bank for International Settlements

Abstract: The implications of the presence of derivative instruments for price movements in underlying financial markets are tested by comparing the variances of price changes over different time horizons before and after the start of organised derivatives trading. It is found that ratios of the variances of multi-day and daily price movements decline for bond prices and stock indices in the United States and Germany, though no such effect is found for Japanese bonds. For the stock indices, the post-derivatives variance ratios are statistically indistinguishable from those that would be characteristic of a random walk, though this is not found to be the case for the bonds. This is interpreted to mean that derivatives accelerate the incorporation of new information into asset prices.

Pages: 28 pages
Date: 1996-01
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Citations: View citations in EconPapers (2)

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