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. Warwick Business School Financial Econometrics Research Centre, University of Warwick.

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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
Date:	1999
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Status:	Not Peer Reviewed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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URI:	http://wrap.warwick.ac.uk/id/eprint/1834

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