Volume determination in stock and stock index futures markets: An analysis of arbitrage and volatility effects

Abstract

he pricing of futures contracts relative to their underlying cash assets via no-T arbitrage relations has been a subject of extensive theoretical and empirical research. Recent studies of arbitrage-enforced relative futures-cash pricing restrictions by Elton, Gruber and Rentzler (1984);and Hegde and Branch (1985) for Treasury bill futures,' and by Modest and Sundaresan (1983); Cornell and French (1983);and Figlewski (1984) for stock index futures, report varying degrees of apparently significant deviations from fair cost-of-carry pricing. These results are of both practical and academic interest. First, the failure of such elementary no-arbitrage relations suggests that systematic market inefficiencies exist? implying simple riskless strategies through which portfolio managers may improve returns. Second, these deviations from no-arbitrage relative pricing suggest that excess risk is borne by hedgers who must close out their positions prior to contract expiration.While many studies have examined the pricing restrictions implied by arbitrage activity, little attention has been given to the implications of arbitrage activity for the determination of trading volume in both cash and futures markets. In particular, necessary to uncover the hidden costs and impediments to arbitrage.

Mispricing, Volume, Volatility and Open Interest

“…This is also contrary to the fi ndings of Chan and Chung (1993) for MMI index in the US market that the increase in mispricing leads to the increase in the cash trading volume and the cash and futures price volatility. My fi ndings are more in line with those of Hemler and Longstaff (1991) and Merrick (1987). The lagged values of FVOLA explain the variation in the maximum number of other variables.…”

Dynamic spillover effects in futures markets: UK and US evidence

“…Indeed, the examination of net pairwise spillovers between futures volatility and volume of trading indicates that futures volatility generally leads trading volume in the US. These results resonate well with Merrick (1987) who finds that volatility can significantly cause trading volume in the US stock market, but evidence of causality in the opposite direction is weak. Bryant et al (2006) reject the hypothesis that large speculator and small trader activity, calculated as twice the level of open interest, causes futures volatility.…”

Assessing the intraday relationship between implied and historical volatility

“…This result is consistent with previous work [Ekman (1992); Kawaller, Koch, and Koch (1990);Merrick (1987)], and it underscores the need to control for changes in volume when attempting to uncover the IeadAag relationship between historical and implied volatility. No stable analogous relationship is evidenced between volume and implied volatility in option prices.…”