The effect of futures markets on spot market volatility: Empirical evidence from 3-month Canadian bankers' acceptances

Futures markets have been blamed for higher volatility in the underlying asset market. A popular belief is that trading activity in futures markets encourage speculation, which destabilizes the spot market. The alleged destabilization takes the form of higher spot market volatility. On the other hand, a favorable view is that futures trading helps stabilizing the underlying market and leads to more complete markets and enhanced information flows. The numerous papers that have studied the effect of the introduction of derivatives on the underlying assets have obtained different results. This paper analyses the effect of the introduction of futures markets on the underlying market for Canadian bankers' acceptances. More specifically this study investigates the contention that the introduction of the futures (BAX) on the Montreal exchange on April 24th 1988 has affected the volatility of the underlying asset. To study this effect, several models and approaches are used such as the GARCH process and others models and approaches formulated by several academics who studied this issue for other underlying spot markets.