Gold Derivatives: Gold Derivatives: - World Gold Council

the GNMA market, reduced random fluctuations in GNMA spot prices, and led
to the GNMA market being better integrated with the Treasury bond market.
Simpson and Ireland (1982) also looked at the volatility of GNMA yields before
and after the opening of the futures market, controlling for the volatility of Treasury
and FNMA bond prices, and concluded that ‘trading in GNMA futures did
not affect the volatility of cash prices for GNMA certificates’.
Figlewski (1981) regressed the volatility of GNMA prices on the amount of open
interest and the volume of trading in the futures market over the period 1975-79,
and found a positive if weak relation, which suggested that futures trading activity
led to an increase in spot price volatility. However, the results are sensitive to
the comparison period used. When Moriarty and Tosini (1985) extended the
sample period to 1983, they found no evidence that the opening of the futures
contract affected volatility of the spot market.
The fundamental problem with these studies is their lack of power to identify any
causal link. Showing that market quality measures are on average different in the
periods before and after the market opens is not compelling evidence of a link
between market quality and the existence of a futures market. Using a measure of
futures activity, such as volume or open interest, as an independent variable helps
very little since it too is highly correlated with time.
Seeking to avoid these problems Bhattacharya, Ramjee and Ramjee (1986) look
at the time series properties of daily volatility in the cash and futures market and
test whether unexpectedly high volatility in one market is followed by increased
volatility in the other. They find weak evidence of futures volatility leading spot
market volatility in one of their tests, but the magnitude of the effect is not large,
and the effect vanishes in a second, similar test. They conclude that the ‘actions
[of speculators in the futures market] do not appear to cause any destabilizing
effects in the cash market.’ The implications one can legitimately draw from a
test of this sort are quite limited; the fact that high volatility in the futures
market is followed by high volatility in the cash market does not necessarily
mean that the volatility in the cash market is caused by the futures market.
Rather all it may show is that the futures market reacts more swiftly to news
than does the cash market.
Bortz (1984) examines the volatility of Treasury bond prices before and after the
introduction of the Treasury bond futures contract in 1977. After correcting for
macro-economic variables he finds a small reduction in volatility. When using
futures market trading volume and open interest as explanatory variables, he finds
coefficients which are insignificant though negative. He concludes that his results
‘while not powerful, are consistent with the notion that the T-bond futures market
helped reduce the daily volatility in cash bond prices’.
104
Gold Derivatives: The market impact