Introduction
he controversy created by "Black Monday" and the recent stock market crash Many of the proposals to deal with the perceived increased volatility' are actually proposals to increase market frictions by increasing transaction costs, increasing margins, limiting arbitrage, or banning trading in futures. This article argues that these proposals will indeed succeed in reducing short-run price volatility, but that they will have no effect on long-run volatility.
Much of the blame for increased volatility is placed on the futures market and its links with the cash market.' Cash market participants have a long history of objecting to futures markets. Past research provides little support for this opposition. An extensive review of the literature (Committee on Agriculture (1985, p. 204)) summarizes research on the effects of futures on cash markets: "the findings of these studies are fairly impressive in that they generally show that the introduction of new derivative markets either did not significantly affect the variability of cash market prices or reduced it."
It seems unlikely that so much opposition to futures markets is totally irrational as past research seems to suggest. This study extends the arguments of Brorsen, Oellermann, and Farris (1989) that futures markets cause cash markets to adjust more sharply which, in turn, increases price variability in the short-run. This increase in short-run price variability may explain the opposition to futures markets. Short-run volatility appears to be a major concern for stock market regulators and participants. The proposed "circuit-breakers'' are specifically designed to reduce volatility in the short run.
T has led to much interest in developing regulations to reduce price volatility. The author is grateful to Franklin Edwards and Scott Irwin for their helpful comments. 'Whether volatility has increased or not is still a subject of some controversy. Edwards (1988) ar-'See Report ofthe Presidentiul Tusk Force on Market Mechanisms (1988) for an example.
gues it has not, while Harris (1989) found only a small increase.