The causal relationship between futures price volatility and the cash price volatility of GNMA securities

✍ Scribed by Anand K. Bhattacharya; Anju Ramjee; Balasubramani Ramjee

• Publisher: John Wiley and Sons
• Year: 1986
• Tongue: English
• Weight: 615 KB
• Volume: 6
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990060104

✦ Synopsis

utures markets arose from the need to reduce price risk. The economic functions F of futures markets are to provide an arena for competitive market price discovery, a hedging vehicle for producers and processors of actual commodities, and a means for improving the efficiency of the market.

However, futures markets also encourage speculation, although the existence of futures markets is not a necessary and sufficient condition for speculative activity. Despite the negative connotation sometimes associated with the word, profitable speculation is considered by some economists (Friedman, 1953) as a catalyst for price stabilization. Since the futures markets are characterized by a high degree of informational efficiency, the effects of such stabilization wili permeate to the cash markets. However, the opposite viewpoint (Kaldor, 1939 andBaumol, 1957) alleges that speculators promote price destabilization which spills over into the cash markets and induces price volatility in the cash markets. This view contends that futures market volatility is the change agent causing the volatility in the cash market of a particular security.' A practical implication of this hypothesis is that if futures market volatility causes cash market volatility, then the latter variable can be considered as a leading indicator of forthcoming changes in the cash market and *The authors would like to thank the editor of Journal ofFuiures Markets, Dr. Mark Powers, and two anonymous 'Figlewski (1981) has also mentioned the possibility of reverse causation with the change agent in futures price volatility being the cash price volatility in situations where unstable prices in the cash market evoke an increased volume of hedging in the futures market.

reviewers for helpful comments and suggestions.