Impact of Future Derivatives on Stock Market Volatility
Derivatives has been the talk of the financial world after it was accussed as the primary reason for such a deep financial crisis that affecetd the global economy in 2007. Thus, the modelling of asset returns and judging the volatility of stock market and whether the derivatives have a substantial effect on stock market volatility, is still the key task for every finance professional as it provides much needed on risk patterns involved in investment process. The Finance Gurus propose that stock market normally exhibit high levels of price volatility and cause concerns to the investor regarding unpredicatble outcomes, however with launch of derivatives in the nineties in the major financial hubs, the volatility of stock market has become more complicated with derivatives offering new areas and scope of hedging and speculation. Thus, it is important to examine the impact of derivatives on stock market volatility. (O'Connor)
At time of introduction of derivatives, it was said that it is being launched with the twin objective of increasing liquidity and mitigation of risk. However, the finance world is still figuring it out whether these objectives have been materialized or not as it carries both theoretical and practical importance with it. Thus, with the help of stress testing models like GARCH and other models we will be looking on the impact of future derivatives on stock market volatility.
Introduction:
The completeness feature of the market has generated the need for introducing innovative financial instruments with the objective of creating efficient portfolios along with security from price fluctuations. Thus, with futures and other derivative instruments offeri...
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...micians, this method was developed by Boolersleva nd Taylor. GARCH modles have the ability to allow conditional variance to depend on its previosu lags. Thus, this method allows interpretation of the current variance fiited in the model as weighted function of previous period volatility and fitted variance of previous period. Condluded to beter than ARCH Model, although GARCH(1,1) can be further generalized with GARCH(p,q) model but since GARCH(1,1) captues sufficient volatility most of the practioners avoid GARCH(p,q) model.
GARCH(1,1) is expressed as:
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The new Volcker Rule forbids the proprietary trading and limits the proportion of the hedge fund and private equity fund to no more than 3% for the banks, thus the banks worry about the Volcker rule will lead them to spend 10 million dollars to market making, insurance and risk hedging.
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The expanding global market has created both staggering wealth for some and the promise of it for others. Business is more competitive than ever before, and every business, financial or product-based, regardless of size or international presence is obligated to operate as efficiently as possible. A major factor in that efficient operation is to take advantage of every opportunity to maximize profits. Many multinational organizations have used derivatives for years in financial risk management activities. These same actions that can protect multinational organizations against interest rate futures and currency fluctuations can be used to create profits for those same organizations.
Finance theory does not provide a complete framework for explaining risk management under the fluctuated financial environment in which firm operates. Hence, for corporate managers, they rank risk management as one of their top priorities. One of the strategies to reduce risk is by hedging. This paper will discuss the advantages and disadvantages of hedging risk using financial derivatives.
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Many factors have contributed to the impressive growth of Korean derivatives market. Some of the main contributing factors are:
Chaos theory has numerous application including helping explain phenomena or helping to predict the future. Chaos theory is applicable in various fields ranging from weather, business to medicine. Chaos theory explains the reason why it is practically improbable to predict the weather with the current technology as well as providing a way for people to find patterns in the chaotic system of stock exchange. It also helps with the running of organisation by showing what sort of condition is needed for a profitable business as well as helping doctors predict when heart failure may occur. Fractals which is a concept of chaos theory also is portrayed in the natural world in examples such as lightning and neurons in the brains. Chaos theory has
...ting in hedging activities in the financial futures market companies are able to reduce the future risk of rising interest rates. By participating in the financial futures market companies are able to trade financial instruments now for a future date (Block & Hirt, 2005).
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Using the Modern Portfolio Theory, overtime risk assets will provide a higher expected rate of return, as compensation to the investors for accepting a high risk. The high risk will eventually lower collecting asset classes to the portfolio, thus reducing the volatile risk, and increasing the expected rates of return. Furthermore the purpose of this theory is to develop the most optimal investments portfolio which would yield the highest rate of return while ascertaining the risk for the individual or corporate investor.