The Effect Of Financial Futures Trading On Spot Market Informational Efficiency And Volatility

O'Hara(1995)argues t.hat an issue central to the analysis of market microstructure is the effect of financial innovation and trading practice evolution on price formation process.While financial futures are increasingly important in the capital market system,shifts in the quality of underlying spot market associated with the futures trading are of greater concern to regulators and investors.This paper develops an expectation equilibrium model of a competitive futures market,and then empirically examines the impact of futures trading on volatility and informational efficiency.The current theoretical models which focus on risk sharing aspect of futures trading are mostly based on commodity futures,and highly depend on specific hypotheses regarding behaviors of either producers or consumers.Extending this framework to a speculative environment causes conflicts,Grossman(1977)and Cao(1999)found that introduction of futures market could either eliminate the equilibrium or exert no influence over underlying asset price.In this paper,we relax the traditional assumptions of perfect market.by modeling narrow framing decisions and trading costs frictions,which enable us to highlight the information transmission aspect of futures trading and avoid the situation that the futures contracts turn into redundant assets.We show that the introduction of financial futures is not only benefit to the risk sharing among market participants,but also improves the process in which private information communicates from informed traders to uninformed traders,thereby tends to dampen the spot price volatility and promote a more efficient equilibria.Meanwhile,the noise trading in futures market has detrimental affects on the stability of spot market,so we recommend close monitoring and regulating of over speculation.Afterwards this paper analyzes the relationship between futures trading and informational efficiency of spot market.A non-CSI 300 control group is constructed using multivariate matched sampling methods that incorporate the propensity score,and then difference in difference model is applied to directly examine the influences of the launch of index futures on mispricing of spot market,price adjustment delay and trading information content.The analysis of return variance ratio in different horizon demonstrates the overreaction bias existed in both return series of CSI 300 stocks and non-CSI 300 group.Given firm attributes known to affect efficiency,we found that GSI 300 stocks' mispricing experienced a significant decrease after the index futures listing comparing with that of non-CSI 300 group.The following study investigates the response of individual stock price change to the lag market return,discovers the introduction of futures market make the delay of long horizon pricing adjustment of CSI 300 stock decreases dramatically relative to that of the control group.However,only weak evidence supports the decrease of delay for short horizon pricing adjustment,which implies the improvement.of market efficiency is mainly attributed to information transmission effect of futures trading.Finally,the paper utilize the return variance ratio between market trading hours and non-trading hours to measure the trading information content,the empirical result suggests that the trading information content of CSI 300 stocks is relatively much higher when open interest of index futures is larger,while the non-CSI 300 stocks are not sig-nificantly affected by futures trading activities.The rest of the paper investigates the relationship between CSI 300 index futures trading and spot prices volatility.We found that the unconditional volatility of spot market measured by return standard deviation decreases dramatically after the launch of futures.Moreover,the EGARCH model which controls for global market and Chinese unique factors also confirms a sharp decrease of conditional volatility for underlying index,and the results are robust to asymmetric volatility specification,error distribution,and sample period,etc.Analysis on the structure of conditional variance indicates that volatility shocks are more quickly digested and reflected in the stock market after the index futures listing.More importantly,we partition a speculative futures trading proxy which is in line with regulatory target into expected and unexpected components,and document.that while the unexpected speculative trading volume that reflects new information is a key driven for price changes,the expected speculative trading volume that reflects the process of information impounding and believe updating is negatively correlated with conditional volatility,which supports speculative trading improves the stability of spot market.To ensure the reliability of our inferences,the stochastic volatility models and Hausman test are implemented and further results are consistent with former conclusions.CSI 300 stock index futures contract is the first financial futures product in Chinese stock market.It is a bellwether for the long-term development of the financial sector,which received much attention from investors and regulators.The recognition of the advantages and disadvantages brought by futures market has an important practical significance for the further development of financial derivatives.The theoretical and empirical results of the paper indicate the innovation of financial futures products not only provide investors with new options of asset allocation and risk management,and also may improve the overall operation quality of the underlying spot market.