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Market risk and the concept of fundamental volatility : measuring volatility across asset and derivative markets and testing for the impact of derivatives markets on financial markets

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Hwang, Soosung and Satchell, S. (Stephen) (1999) Market risk and the concept of fundamental volatility : measuring volatility across asset and derivative markets and testing for the impact of derivatives markets on financial markets. Working Paper. University of Warwick: Warwick Business School Financial Econometrics Research Centre. Working Papers Series, Vol.1999 (No.16).

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Official URL: http://www2.warwick.ac.uk/fac/soc/wbs/research/wfr...

Abstract

This paper proposes an unobserved fundamental component of volatility as a measure of
risk. This concept of fundamental volatility may be more meaningful than the usual
measures of volatility for market regulators. Fundamental volatility can be obtained using
a stochastic volatility model, which allows us to ‘filter’ out the signal in the volatility
information. We decompose four FTSE100 stock index related volatilities into transitory
noise and unobserved fundamental volatility. Our analysis is applied to the question as to
whether derivative markets destabilise asset markets. We find that introducing European
options reduces fundamental volatility, while transitory noise in the underlying and futures
markets does not show significant changes. We conclude that, for the FTSE100 index,
introducing a new options market has stabilised both the underlying market and existing
derivative markets.

Item Type:

Working or Discussion Paper (Working Paper)

Subjects:

H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Q Science > QA Mathematics

Divisions:

Faculty of Social Sciences > Warwick Business School > Financial Econometrics Research Centre
Faculty of Social Sciences > Warwick Business School

Library of Congress Subject Headings (LCSH):

Risk -- Econometric models, Stock price indexes -- Econometric models, Options (Finance) -- Econometric models

Series Name:

Working Papers Series

Publisher:

Warwick Business School Financial Econometrics Research Centre

Place of Publication:

University of Warwick

Official Date:

1999

Dates:

Date	Event
1999	Published

Volume:

Vol.1999

Number:

No.16

Status:

Not Peer Reviewed

Access rights to Published version:

Open Access

Funder:

Newton Trust, Institute for Quantitative Investment and Research (Great Britain) (INQUIRE)

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