The impact of index futures trading on underlying stock index volatility empirical evidence from vietnam on VN30

The results of this study indicate that the introduction of futures leads to a change in the spot market volatility of the VN30 index but not significant and there is also the existence

LE CHI TRUNG

THE IMPACT OF INDEX FUTURES TRADING

ON UNDERLYING STOCK INDEX VOLATILITY: EMPIRICAL EVIDENCE FROM

VIETNAM ON VN30

GRADUATION THESIS

MAJOR: FINANCE – BANKING

CODE: 7340201

HO CHI MINH CITY, 2018

STATE BANK OF VIETNAM MINISTRY OF EDUCATION AND TRAINING

BANKING UNIVERSITY OF HO CHI MINH CITY

_

LÊ CHÍ TRUNG

THE IMPACT OF INDEX FUTURES TRADING ON

UNDERLYING STOCK INDEX VOLATILITY: EMPIRICAL EVIDENCE FROM VIETNAM ON

VN30

MAJOR: FINANCE – BANKING

CODE: 7340201

SUPERVISOR: MsC NGUYỄN MINH NHẬT

HO CHI MINH CITY, MAY 2018

ACKNOWLEDGEMENT

A completed study would not be done without any assistance Therefore, the authors who conducted this research would like to express our deepest gratitude my supervisors Nguyen Minh Nhat for his supports, encouragement, invaluable academic advice Since this is a relatively new field at the Banking University of Ho Chi Minh City in particular and of Vietnam in general, so this study required a lot of expertise and knowledge of social psychology in finance Finally, I would like to dedicate my concluding words to all friends and fellows of mine Without their support, the work could not be done successfully

The author would like to undertake research projects with the topic name “The Impact of Futures Trading on Underlying Spot Market Volatility: Empirical Evidence from Vietnam on VN30” The figures and references are cited from clear

source and unity in the references The contents and results of this study have not been published in any public works until the present time The author would like to

be responsible for my commitment

Ho Chi Minh City, May 2018

Student in charge

Le Chi Trung

ABSTRACT

The onset of derivatives in Viet Nam and futures trading in specific may cause the concerns in the participants in market Over the world investors have started using derivatives to manage their risks and futures is one of the most effective one Since derivatives markets interact continuously with spot markets, the effect of derivatives markets on spot market volatility has become an important research topic

The present study tries to estimate the effect of introduction of futures index

on the underlying stock volatility in Vietnamese stock market To estimate the effect

of introduction of derivatives on stock market, GARCH family models which are known for their ability to model volatility Using these models, the asymmetric nature

of stock returns and the volatility of stock returns on the introduction of derivatives are checked Most of the previous studies break the sample period into two sub-periods, one period before the introduction of futures trading and one after that introduction In this paper, we are going to use the same approach In order to capture the volatility, we apply at the same time the EGARCH (1,1), GARCH (1,1) models for the pre-futures period and the post-futures period as well The results of this study indicate that the introduction of futures leads to a change in the spot market volatility

of the VN30 index but not significant and there is also the existence of leverage effect and huge difference of ARCH and GARCH effect impact on spot price volatility in each sub-period

ABBREVIATION

Heteroskedasticity EGARCH Exponential Generalized Autoregressive Conditional

Heteroskedasticity IGARCH Integrated Generalized Autoregressive Conditional

Heteroskedasticity

exchanges

LIST OF TABLE

Table 2.1 Some typical previous research with GARCH Family models 27

Table 4.1 Descriptive and statistics of VN30 closing price in 10/2/2012 – 17/4/2018 43

Figure 4.2 VN30 Daily Closing Price Chart 43

Figure 4.3 VN30 Daily Logarithm Return Chart 44

Table 4.4 Descriptive and statistics of VN30’s return in 10/2/2012 – 17/4/2018 45

Table 4.5 Heteroskedasticity Test: ARCH Effect at latency 1 46

Table 4.6 Heteroskedasticity Test: ARCH Effect at latency 7 46

Table 4.7 Standard GARCH (1,1) model with dummy variable 47

Table 4.8 Standard GARCH (1,1) model in two sub-period 47

Table 4.9 Standard EGARCH (1,1) model with dummy variable 48

Table 4.10 Standard EGARCH (1,1) model in two sub-period 50

TABLE OF CONTENT

ABSTRACT i

ABBREVIATION ii

LIST OF TABLE iii

CHAPTER 1: INTRODUCTION 1

1.1 Necessity of the topic 1

1.2 Objectives and research questions 3

1.2.1 Objectives 3

1.2.2 Research questions 4

1.3 Research methodology 4

1.4 Subject of the research 5

1.5 Scope of research 6

1.6 Significance of study 6

1.7 Thesis structure 7

CHAPTER 2: THEORETICAL FRAMEWORK AND LITERATURE REVIEW 9

2.1 An overview of futures contract 9

2.1.1 Futures contract definition 9

2.1.2 Development of futures trading over the world 10

2.2 Stock Index Futures Trading 12

2.2.1 Index futures trading definition 12

2.2.2 The onset of futures trading in Vietnam 14

2.3 Stock index volatility 16

2.3.1 Stock index in Vietnam 16

2.3.2 Spot price volatility 17

2.4 Theoretical research basis 19

2.4.1 Review previous researches on impact of futures trading on spot market 19

2.4.1.1 Impact of futures trading on spot price volatility in emerging market countries 19

2.4.1.2 Impact of futures trading on spot price volatility in developed market countries 22

2.4.4 General approaches in previous studies 25

2.4.4.1 Determination the impact of futures trading on spot price volatility 25

2.4.4.2 Determination how spot price volatility has been impacted in two sub-period 27

2.4.5 Gaps of previous studies 30

CHAPTER 3: DATA AND METHODOLOGY 32

3.1 Generalized Autoregressive Conditional Heteroskedasticity (GRACH) model 32

3.2 Exponential GARCH model - EGARCH(1,1) 34

3.3 Testing for ARCH effect 35

3.4 Data processing 36

3.5 Research model 37

3.6 Hypothesis 41

CHAPTER 4: RESULTS AND DISCUSSION OF RESULTS 43

4.1 Descriptive statistics 43

4.2 Testing of ARCH effect on the set of data 45

4.3 Empirical findings and results of estimation of GARCH model 47

4.3.1 Results on existence of the impact of futures trading introduction on spot price volatility – GARCH (1,1) with dummy variable 47

4.3.2 Results of GARCH estimation in two sub-period 48

4.4 Empirical findings and results of estimation of EGARCH model 49

4.4.1 Results on existence of the impact of futures trading introduction on spot price volatility – EGARCH (1,1) with dummy variable 49

4.4.2 Results of EGARCH estimation in two sub-period 50

4.4.3 Comparing with other emerging market countries 52

CHAPTER 5: CONCLUSION AND POLICY IMPLICATIONS 54

5.1 Conclusion 54

5.2 Policy implications 55

5.3 Limitation and suggestion for further research 57

REFERENCE i

APPENDIXES vi

CHAPTER 1: INTRODUCTION

1.1 Necessity of the topic

There has been widespread interest in the effects of futures trading on prices

in the underlying spot market. It has often been claimed that the onset of derivative trading will destabilize the associated spot market and so lead to an increase in spot price volatility in some market.

Considerable controversy exists over the influence of index futures trading on

the underlying stock market volatility. Concern over the impact of futures enhanced following the stock market drop of October 1987 (Brady, 1988). Despite, there are abundant of studies having been undertaken, there continues to be little agreement

on the effect that futures trading has on spot market volatility (see, for instance, (Aggarawal, 1988), (Baldauf & Santoni, 1991),and (Antoniou & Holmes, 1995). Any increase in stock market volatility that has followed the onset of futures trading has generally been taken as justifying the traditional view that the introduction of futures markets enhance destabilizing speculation.

The results from (Butterworth, 2000) reported for the Mid 250 index indicate

that while the existence of futures trading has made little impact on the underlying

level of volatility, as measured by the standard deviation, it has altered significantly

the structure of spot market volatility. Specifically, while there is evidence of more information flowing into the spot market following the onset of trading, this new information is impounded into prices less rapidly than before the onset of trading, leading to an increase in the persistence of volatility.

The debate on this topic has become more heated when there are also some

findings proving that the introduction of futures has not caused impact on spot price volatility. The results in (Antoniou & Holmes, 1995) suggest that futures trading has led to increased volatility, but that the nature of volatility has not changed post-

futures. The finding of price changes being integrated pre-futures, but being stationary post-futures, implies that the introduction of futures has improved the speed and quality of information flowing to the spot market. Therefore, the significance of findings on existence of futures contract’s effect on volatility spot price is considered seriously in this research. Hence the evidence suggests that there has been an increase in spot price volatility on a daily basis, but that this is due to increased information in the market and not to speculators having adverse destabilizing effects. Indeed, this increased volatility appears to be the result of futures trading expanding the routes over which information can be conveyed to the market.

There are some approaches the impact of futures index on spot market

volatility and GARCH model is usually utilized to detect the existence of futures

contract effect. (Sathya, 2009) study has been documented, however, that time series returns for speculative markets show a clustering of fluctuations, i.e. larger changes tend to be followed by large changes, and small by small of either sign. This appears

to be the case for NSE Nifty. Such observations question the validity of linear regression models constructed under the assumption of homoscedasticity of the variance. It is for this reason that GARCH, which allows for time-varying variance

in a process, is more appropriate to an analysis of volatility.

With the introduction of futures trading in the emerging market as Vietnam, the estimation of the quality of the information flowing into the market and determine how fast it can impound into the stock market volatility. More importantly, the impact

of the onset of futures trading is considered cautiously in this research using some methodologies as previous studies. The initial findings in this field are concluded when futures has just traded for only 9 months are also the foundation and base for the further research and continue to review these result for the longer period and develop in more fruitful and practical way.

Most of the previous studies done in the many financial markets (including developed and emerging countries, where generally, focused on the impact of the futures market on the spot market volatility. There were also some gaps and with specific assumption for each nation. So, I want to conduct this research in the Vietnamese market and make it initial study in this field and also compare results with other countries categorized emerging, the specific objectives of this study are presented in the following section.

1.2. Objectives and research questions

We try to make our objectives clear in this study and put more attention into the main goals in order to have right direction to achieve the empirical findings with the most effective methodology. We also refer the previous studies on the way how they can set the ultimate goal in the same topic then the author apply and modify our target to be appropriate in this research. The objectives after the author consider cautiously will be presented in the following section

1.2.1. Objectives

Purpose 1: Determine the existence of impact of futures trading on the

volatility of the underlying spot market. If there is existence of futures trading impact

on volatility, this study’s finding is how spot price volatility is affected

Purpose 2: Find out whether the futures trading improves or decreases the

quality and speed of information flowing to spot markets thereby having deep understanding on the market and propose the initiatives for stock market participants.

1.2.2. Research questions

First, is there the effect of introduction of futures contracts on spot price

volatility the effect of introduction of futures contracts on spot price volatility?

Second, if the existence of futures trading does affect volatility, how does it,

that is, what is the relationship between information and volatility following the onset

of futures trading?

Third, is the spot price volatility in Vietnamese market after the onset of

futures trading consistent with empirical findings in other emerging economy market like Vietnam?

1.3 Research methodology

When investigating the impact of futures trading on underlying spot market volatility it is necessary to consider volatility both before and after the onset of futures trading using an approach which is capable of detecting not only whether volatility has changed but rather why it has changed In addressing these issues, previous studies have employed the Generalised Autoregressive Conditional Heteroscedasticity (GARCH) family of techniques By providing a detailed specification of volatility these techniques enable the link between information and volatility to be considered I also use dummy variable to examine the statistical significance of impact of futures trading on spot market volatility

After that, more important than that how the onset of futures trading affect on the volatility, the investigation utilized the GARCH family of statistical models to investigate volatility in VN30 spot prices both before and after the onset of futures trading The standard GARCH (p, q) model introduced by Bollerslev suggests that the conditional variance of returns is a linear function of lagged conditional variance terms and past squared error terms

In analyzing the relationship between information, spot price volatility and the impact of futures trading, there are two issues that need to be addressed First, does the existence of futures trading in itself have any effect on volatility? Second, and perhaps more important, if the existence of futures trading does affect volatility, how does it, that is, what is the relationship between information and volatility following the onset of futures trading? To address the first issue, we augment the conditional variance equation with a dummy variable taking on the value zero pre-futures and one post-futures If the dummy is statistically significant then the existence of futures trading has had an impact on spot market volatility To address the second issue, the period under investigation is partitioned into two sub-periods relating to before and after futures trading began GARCH models are estimated for both sub-periods, thereby allowing a comparison of the nature of volatility before and after the onset of futures trading (Antoniou & Holmes, 1995)

To analyze the effect of the introduction of futures contracts on spot price volatility, both GARCH and EGARCH models are employed Both of those models are used in order to check the most appropriate models for our time series Developed

by Bosselver and Taylor (1986), GARCH (p,q) model is used to capture better the tendency of returns to exhibit volatility clustering of financial series In this model, positive and negative past values have a symmetric effect on the conditional variable

1.4 Subject of the research

To inspect the impact of futures trading on the spot price volatility, the subject

of the research should be defined clearly which allow us to keep forward to the

ultimate goal Thus, the subject in this research is the change or the volatility of spot

price in specific stocks in VN30 during both pre-futures and post-futures

1.5 Scope of research

This study is going to examine the effect of futures trading on the spot market

volatility Thus, the scope of this study just focus on the return volatility of stocks

which is in VN30 in period from February 2012 to April 20118

In order to satisfy the requirements of statistical models we need an appropriate

period of time that why this study is going to study in the period from 10 th February

2012 (when the onset of VN30 officially introduce to public) to 17 th April 2018 which

is the most recent time from the introduction of futures to now This period is considered to cover the period from both pre and post-futures but it may cause the imbalance for the separation of two sub-periods

1.6 Significance of study

In the last decade, over the world many emerging and transition economies have started introduction of derivative contracts, in the context of globalization, Viet Nam’s economy has integrated immensely especially stock market has become the attractive investment channel that draw attention from both many types of investors and economists or researchers. In 2017, there is unforgettable milestone in Viet Nam stock market history that is the onset of futures trading.

Trading on Top 30 market capital listed companies at Ho Chi Minh Stock Exchange (Hose) was introduced on the August, 2017. The launch of derivative products like index futures has significantly altered the movement of the prices in the spot market. This research examines the impact of trading in the VN30 Stock Index Futures on the volatility of the underlying spot market. To examine the relationship between information and volatility (as subject neglected in previous studies) the GARCH family of techniques is used.

Beside that the key contribution of this study is to find out the relationship between the futures index with the volatility of spot market and does the onset of futures trading in Vietnamese market really impact on the volatility of the spot market

putting in this context which there has been no research on this similar topic. Thus the issue for this area of focus has been still controversy and especially the consequences of spot market after the onset futures trading in Vietnamese market will

be also considered and compared with other consequences of the onset derivatives in other countries (both emerging and developed countries).

In addition to finding of impact of futures trading on spot price volatility, I also apply other method to overcome the drawbacks and gaps of the previous studies, such as the restriction of parameters in GARCH model and only. In the presence of

an asymmetric response to news the standard GARCH model would be misspecified leading to incorrect inferences regarding the relationship between information and volatility. This in turn may result in inappropriate policy conclusions being drawn. In these circumstances an alternative GARCH model is required to test for asymmetries,

to allow differentiation between the effects of good news and bad news on volatility.These shortcomings are mentioned and the solutions are also suggested to address issues in the following sections.

1.7 Thesis structure

Chapter 1: Introduction

In this chapter, I focus on depicting and delivering my initial idea and how I can execute the thesis step by step after figuring out the objectives of the thesis, the subject of the thesis, the scope of the thesis,… Then we also raise the great interest and significance of these in this field

Chapter 2: Theoretical framework and literature review

This chapter is the most important in the thesis since it can play the crucial role in thesis and it is also important to readers perceive the general concept of the author We go through for the whole process from the beginning with general concept to the details of definition such as futures definition, the futures contract and especially the stock volatility Moreover, we can show the results in previous

studies, how they apply the model to address issues and explanation for selecting the appropriate models in capturing the volatility of VN30 stocks

Chapter 3: Methodology and data

This chapter presents methodologies that are used for capturing the volatility

of spot price and determining the effect of futures trading on the spot price market In this chapter we provide the perception of GARCH model, its advantages and disadvantages compared with other conventional models, we also consider the GARCH family models and take it into account to overcoming the drawbacks of GARCH Furthermore, the asymmetric response is also addressed using EGARCH models The data samples and processing data are also expressed

in this chapter for readers easily follow up the thesis

Chapter 4: Results and empirical findings

The empirical findings are also presented in this chapter when applying both GARCH (1,1) and EGARCH (1,1) model in order to detect the impact of futures trading More importantly, the results in this chapter is really significant to analyze and compare the empirical results regarding the ARCH and GARCH effect in our model and how the information and news impact on the spot price volatility after the introduction of futures What is more, the results in this chapter can show us the leverage effect in the market and confirm whether the existence

of asymmetric response in two sub-period or not

Chapter 5: Conclusion and implication

The summary result and the connection between the empirical findings and reality can be logically presented in this chapter We also give some recommendations that are based on experiences in the world, situation

in Vietnam, and results of this study This chapter also goes to clarify its limitations and suggests some new direction studies

CHAPTER 2: THEORETICAL FRAMEWORK AND LITERATURE

REVIEW

2.1. An overview of futures contract

2.1.1. Futures contract definition

In finance, a futures contract (more colloquially, futures) is a standardized forward contract, a legal agreement to buy or sell something at a predetermined price at a specified time in the future. The asset transacted is usually a commodity or financial instrument. The predetermined price the parties agree to buy and sell the asset for is known as the forward price. The specified time in the future—which is when delivery and payment occur—is known as the delivery date. Because

it is a function of an underlying asset, a futures contract is a derivative product (Durbin, 2010)

Contracts are negotiated at futures exchanges, which act as a marketplace between buyers and sellers. The buyer of a contract is said to be long position holder, and the selling party is said to be short position holder. As both parties risk their counter-party walking away if the price goes against them, the contract may involve both parties lodging a margin of the value of the contract with a mutually trusted third party. However, futures contracts also offer opportunities for speculation in that a trader who predicts that the price of an asset will move in a particular direction can contract to buy or sell it in the future at a price which (if the prediction is correct) will yield a profit (Durbin, 2010)

The underlying asset in a futures contract could be commodities, stocks, currencies, interest rates and bond. The futures contract is held at a recognized stock exchange. The exchange acts as mediator and facilitator between the parties. In the beginning both the parties are required by the exchange to put beforehand a nominal account as part of contract known as the margin

2.1.2. Development of futures trading over the world

Japan established the earliest recognized futures trading exchange in 1710 as

a way to trade rice futures. By 1710, merchants were trading futures contracts based

on the perceived future value of rice. 1710 is the official date at which the modern futures exchanges market is thought to have begun. Why was a rice exchange so important in Japan? Well, Japan’s feudal lords and samurai during this time period weren’t paid in cash: they were paid in rice. That’s why the rice broker industry became so important: samurai and feudal lords needed to exchange rice for cash, and places like the Dojima Rice Exchange gave them a market in which to do it. In fact, the brokers on the Dojima Rice Exchange are credited with introducing and spreading paper money across Japan. They’re also credited with creating modern futures exchanges.

In the 19th Century London was the Next Major Region to Employ Futures Trading. Stock market trading in general is linked back to coffee houses in 16th century London. English futures trading has similar origins, tracing its roots back to the opening of London’s Royal Exchange in 1571. The London Metal Exchange – known officially as the London Metal Market and Exchange Company – was founded

in 1877. This exchange was responsible for trading copper, lead, and zinc, firmly establishing metals and ores as key commodities on futures markets. Between the 1970s and 2010, metals like aluminum, nickel, tin, steel, cobalt, and molybdenum would be added.

More than a century later, in 1848, the Chicago Board of Trade (CBOT) formed, becoming the first official commodity trading exchange in the west. The first traded futures contract in the U.S. was corn, followed by wheat and soybeans. Several years later, the first forward contracts in cotton began trading in New York, and other contracts, including cocoa, orange juice, sugar, cattle and pork futures, soon followed.

By the 1970s, the Chicago Mercantile Exchange (CME) started offering futures trading in foreign currencies and the New York Mercantile Exchange (NYMEX) began offering various financial futures, including U.S. Treasury bonds and stock index futures.

Later, in 1874, the CBOT created the Chicago Produce exchange, which was renamed to the Chicago Butter and Egg Board in 1898. During the First World War, the exchange suspended activity. Then, in 1919, it was reorganized into the Chicago Mercantile Exchange, or CME.

The Chicago Mercantile Exchange (CME) solidified its place as the world’s largest futures exchange in 2008, when CME acquired NYMEX Holdings, Inc., the parent company of the New York Mercantile Exchange and Commodity Exchange.

We mentioned above that the Chicago Mercantile Exchange started offering futures trading in foreign currencies starting in 1972 with the founding of the International Monetary Market. This was just one of several major expansions in futures trading that occurred in the 1970s. In New York, the New York Mercantile Exchange began

to offer trading in various financial futures, including US Treasury bonds. Eventually, the NYMEX would offer futures trading in stock market indexes. A division called the Commodities Exchange also allowed for futures trading in gold, silver, and copper. Platinum and palladium were added later after the US dollar removed itself from the gold standard. During this time period, futures contracts became available

on the Dow Jones and S&P 500 stock indexes.

Today, futures trading exchanges can be found all over the world, but America remains the home of the most active futures trading markets. That’s because two of the most-heavily traded markets are the US bond market and the wheat market, both

of which have an active worldwide presence.

The history of futures trading is as old as civilization itself. It can be traced back to ancient Babylon and Greece, when merchants exchanged forward contracts.These merchants all sought the same thing: they wanted to cash in at a fixed price today to avoid the risk of tomorrow. Futures traders, on the other hand, sought to buy

at a low fixed price today on the assumption that prices would rise in the future.

Over time, we’ve seen the logical progression of futures trading, from American agricultural futures markets in the Midwest, all the way to the modern currency trading and financial futures exchanges that started in the 1970s and has come to dominate the futures markets to this day.

2.2. Stock Index Futures Trading

2.2.1 Index futures trading definition

In the form futures, we have a variety of kind of underlying market such as commodity, natural resources, financial instrument Thus, after having general on futures trading, in this research we just put more attention on the stock index futures which is really important to comprehend significance of the index futures and it would be the huge shortage if we just have understanding the futures definition

In finance, a stock market index futures is a cash-settled futures contract on the value

of a particular stock market index, such as the S&P 500. In the stock index future, the counterparties agree to trade the underlying index at a certain time for a certain price.Because it is impossible to physically deliver the index stock market index futures are settled in cash, especially if the underlying assets are indices. Financial futures maybe traded like other futures. A security that uses composite stock indexes to allow investors to speculate on the performance of the entire market, or

to hedge against losses in long or short positions. The settlement of the contracts is

in cash (Stock Index Future, 2009)

Stock index futures are used for hedging, trading, and investments. Index futures are also used as leading indicators to determine market sentiment. Hedging using stock index futures could involve hedging against a portfolio of shares or equity index options. Trading using stock index futures could involve, for instance, volatility trading (The greater the volatility, the greater the likelihood of profit taking – usually taking relatively small but regular profits). Investing via the use of stock index futures could involve exposure to a market or sector without having to actually purchase shares directly (David Harper, 2018)

Next, after having a brief about the stock index futures, we want to introduce its basically contract based on index and its underlying spot market An index futures contract states that the holder agrees to purchase an index at a particular price on a specified date in the future. If on that future date the price of the index is higher than the agreed-upon price in the contract, the holder has made a profit, and the seller suffers a loss. If the opposite is true, the holder suffers a loss, and the seller makes a profit. Futures contracts are legally binding documents specifying the detailed agreement between the buyer and seller. It differs from an option in that a futures contract is considered an obligation, while an option is considered a right that may or may not be exercised (CME Group, 2013)

A contract for the future delivery of a sum of money based on the value of a stock index. Unlike other futures contracts, in which a given commodity is specified for delivery, stock index futures call for cash settlements because it is not possible to deliver an actual index This futures contract can be used to speculate on the futures direction of stock market (rather than just a few stocks) or to hedge a portfolio of securities against general market movements

2.2.2. The onset of futures trading in Vietnam

After 17 years of development, the stock market in Vietnam has reached an intensive level of stability and requires further completion of the market structure. In particular, the derivative market is a necessary piece to perfect the overall picture of Vietnam's stock market. Vietnam will have a derivative market on August 10, next

to a market that has existed for more than 17 years. However, Pham Hong Son, deputy chairman of the State Securities Commission, should not expect much in the market's first trading day, as this is a new market and the level of risk. Very high, it should be

a cautious route. Besides Singapore, Malaysia, Indonesia and Thailand, Vietnam will

be the fifth country in ASEAN to have a derivatives market and be the 42nd country

in the world to have such a high financial market.

As an effective hedging tool, derivatives can also increase the risk for investors. With derivative tools, investors can create positions similar to short sales.For example, when investors expect the VN-Index to go down and sell a short-call contract, if the forecast is wrong, the VN-Index rises, then investors face the risk unlimited losses. In addition, when entering the derivative market, by simply spending small initial capital, speculators will often use high leverage, which will increase the level of risk and increase price fluctuations in the underlying market.

In Vietnam, with Decision No. 366 / QD-TTg of the Prime Minister, the project on building and development of Vietnam's stock exchange market, in particular the construction plan, the development roadmap for the stock market and the organization Implementation has been approved. Accordingly, the development roadmap for the stock market is divided into three main phases: the preparatory phase for 2013-2015: the development of the legal framework, the improvement of material facilities for the operation of the derivative market; Trial Period 2016-2020: Organize the trading of derivative securities based on underlying assets as securities, with a design and transaction roadmap in each period, ie, futures contracts index ; Option

Bonds Index Treasury Bonds, Futures contract and Option stock-based. Finally, the completion period after 2020 is to develop a unified derivative stock based on international practices, futures contract and option trading based on interest rates, foreign exchange, gold and commodities. Thus, if implemented in accordance with the roadmap, in 2016, the stock market will officially start operating with test products is the charter based on the stock market index.

The practice shows that commodity and currency derivative transactions in Vietnam have been established for a long time and there are certain developments.For example, derivatives for some export agricultural products, such as rice and coffee, have emerged from the 2005-2006 period, with product futures contracts, commodity futures contracts due for one Number of commercial banks acting as intermediaries. For currency risk, derivative products available on the Vietnamese market are customer contracts, option contracts, swap contracts for foreign currencies and interest rates and are often traded directly between a party is a commercial bank with the other party being an individual, business, or financial institution. In the period of hot stock market of 2007 - 2008, some derivative products, mainly stock option contracts were traded directly on the OTC market between securities companies and customers. Although there are no statistics on these types of informal derivative securities, their emergence has indicated the need for investors and the emergence of formal derivatives markets as essential to general development of the stock market.

The scale of Vietnam stock market is still relatively modest compared to other countries in the region and the world. Compared to the world market capitalization, Vietnam's market is just 0.09%. The size of the capital market compared to the economy of Vietnam is also in the lowest category, with a capital market ratio of

33.7%. On a small scale, the interest and participation of foreign investors is quite limited. According to statistics, trading value of institutional investors in the past 12

months accounted for about 14.5% of the total trading value of the market (Hai Ho, 2017)

In addition to the challenges of building a legal and infrastructure corridor for the organization and operation of the derivative stock market, liquidity issues are also

a major challenge when the market is officially operational. For a small scale stock market and the level of participation of domestic and foreign institutional investors is still relatively modest, attracting investors to participate in the first phase will be a factor. It determines the success of the stock market

Since the first month of futures trading, the stock market has attracted the attention of investors, through the growth of both the volume of contracts, the value

of transactions and the number of accounts opened in the first place within the first month There are 7,849 derivatives trading accounts opened in the stock market securities companies The total volume of transactions in the past month was 85,641 contracts, equivalent to the transaction value reached 6,450 billion (Huy Phuong, 2017)

2.3 Stock index volatility

2.3.1 Stock index in Vietnam

This research just focuses on making clearly and determine relationship between the introduction of index futures trading and underlying spot market

volatility specifically on VN30 As discuss in section 2.2.3 the index futures is also

VN30 – its volatility of underlying spot market is also figure that we have to focus and we want to put addition explanation for VN30 index in this section to make it detail In Vietnam, there are some indices used in measurement and reporting of changes in the market value of a group of stocks/shares such as VnAllshare, VN-Index, HNX-Index, HNX30, VN30 they also have their own functions The rule and condition select stocks for VN30 basket can be clearly defined

On 05/01/2012, the Chairman of the Board of Directors of Ho Chi Minh City Stock Exchange has signed the Decision to set up the Council of Indicators and sign the issuance of the Regulation on building and managing the index VN30 and Regulation on the organization and operation of the Council of Indicators The share

of components in the index does not exceed 10% The index is calculated based on the market capitalization method that adjusts the free float rate HOSE has not set the base date and the base value

Index = Current market capitalization value (CMV) / Based Market capitalization value (BMV)

In particular, free-float rate changes of component stocks will be adjusted every 6 months with the time of index review

Rate of free-float (f) = (Outstanding shares-Non-transferrable outstanding shares) / Outstanding shares

Common stocks listed on the HOSE included in the index calculation must not belong to one of the following categories: Shares subject to warning, controlled, suspend trading within 3 months by the time of review The stock has time to list and trade on HOSE less than 6 months; For newly listed shares with average market capitalization in the period under review, the top 5 listed in the list of indexes listed below and traded below 3 months

2.3.2. Spot price volatility

The spot is a market for financial instruments such as commodities and securities which are traded immediately or on the spot. In spot markets, spot trades are made with spot prices. Unlike the futures market, orders made in the spot market are settled instantly. Spot markets can be organized markets or exchanges or over-the-counter (OTC) markets.

Volatility is a statistical measure of the dispersion of returns for a given security or market index. Volatility can either be measured by using the standard deviation or variance between returns from that same security or market index.Commonly, the higher the volatility, the riskier the security.

In finance, volatility (symbol σ) is the degree of variation of a trading price series over time as measured by the standard deviation of logarithmic returns.

A market’s volatility is its likelihood of making major, unforeseen short-term price movements at any given time. Highly volatile markets are generally unstable, and prone to making sharp upward and downward moves. Markets with low volatility are less likely to see such spikes, and are as such more stable (Serge Berger, 2016)

As a general rule, most highly volatile stocks come with greater risk, but also greater chance of profit. This is why most traders try to match the volatility of a particular asset to their own risk profile before opening a position.

In this research the author using spot price market volatility on return of the underlying stock not its daily price as the following formula:

speculation, which further complicates the volatility behaviour of the stock markets (Mallikarjunappa & M, 2008)

2.4. Theoretical research basis

2.4.1. Review previous researches on impact of futures trading on spot market

2.4.1.1. Impact of futures trading on spot price volatility in emerging market countries

I would like to examine the empirical results from emerging market countries

to discover the common findings because the fact that these markets have been developing and need derivatives as an efficient financial investment channel to perfect monetary market and boost economic development. One more characteristic

of these markets need to be considered is that these market have experiences from developed market so that experienced and non-experienced investors trading futures with distinguished risk appetite would have different interaction leading to destabilization underlying stock market. An emerging market is a country that has some characteristics of a developed market, but does not meet standards to be a developed market, group of emerging market including : Brazil, China, India, Indonesia, Mexico, Russia, Turkey, Argentina, Bangladesh, Chile, Colombia, Egypt, Iran, Iraq, Kazakhstan Malaysia, Nigeria, Pakistan, Peru, Philippines, Poland, Qatar, Saudi Arabia, South Africa, Thailand, Vietnam. A quick general view on previous results reveals that the onset of derivatives is the contributing factor of increasing spot price volatility but in some cases, there are opposite findings. Thus, the study on Vietnamese market is unquestionably significant among emerging market countries.

Other findings proved that the GARCH analysis confirmed no structural change after the introduction of futures trading on Nifty, and found that whilst the pre-futures sample was integrated, the post-futures sample was stationary. Spot

returns volatility is found to be less important in explaining spot returns after the advent of futures trading in NSE Nifty (Sathya, 2009)

While the pre-futures sample was integrated, proposing that shocks have a permanent effect on prices, the post-futures sample was found to be stationary. This implies that the quality of news flowing to spot markets are improved by the futures trading, and spot prices accordingly reflect more promptly changes that occur in demand and supply conditions. The integration of the pre-futures market illustrates the lack of news and associated spot price inflexibility in the market. This inflexibility prevents the immediate and continuing adaption of prices in response to demand-supply conditions timely and necessitates eventual larger price and resource adjustments

Turning to evidence for China, Arisoy (2008) examines the introduction of the SGX FTSE Xinhua China A50 index futures contract on the volatility and liquidity

of its underlying spot market. The findings indicate a significant increase in spot volatility and liquidity in the post-futures period. Conditional volatility estimations suggest that the change in volatility is attributed to an increase in the rate of flow of information to the spot market, rather than speculative trading

We follow the majority of papers cited here in choosing a GARCH approach

to model volatility spillovers for data at the daily frequency. However, owing to its recent creation the sample from the mainland Chinese market(s) is shorter than in some of the studies mentioned above. In general, samples based on the experience of emerging markets tend to be shorter than in papers that investigate the impact of futures markets on spot markets in mature economies

Overall, previous findings find robust evidence in favor of the stabilization hypothesis. The regression analysis results show that the onset of CSI300 index futures had a significant and negative impact on the volatility of the CSI300 spot index, as well as on both the A50 and HSCEI spot markets. In contrast, the

introduction of A50 and HSCEI index futures had unanimous but certainly not calming effects on their respective underlying spot markets, may well combine to explain why Chinese market resembles its counterparts in mature economies more so than in emerging markets (Bohl, Diesteldorf, & Siklos, 2015)

Generally, the foregoing findings are confirmed by the results of the estimation: The introduction of CSI300 index futures had a calming effect on the volatility of its underlying spot market. Moreover, a positive and significant coefficient CSI now suggests spillover effects between the HSCEI spot market and the CSI300 spot market. Generally, the results for both EGARCH model specifications confirm previous findings A positive and significant substantiates the spillover effects between the A50 and the CSI300 spot markets. Neither our results for the GJR-GARCH models nor the output for the EGARCH models report any significant leverage effect. Freris (1990) examined the Hang Seng index of the Hong Kong market and found also that the stock market volatility was decreased after the introduction of futures (Bohl, Diesteldorf, & Siklos, 2015)

However, for the markets of Hong Kong and the UK, he found no significant relationship between change in volatility and futures. Chiang and Wang (2002), for the TAIEX futures in Taiwan supported all the previous propositions. In more recent studies, in Asian market, Pok and Poshakwale (2004) and after examination of the Malaysian and the Korean markets respectively, found that the increased volatility of the underlying spot market was due to the onset of futures market (Ryoo & Smith 2004)

What is more, the use of GARCH and EGARCH models to know which model

is appropriated to our times series. Results show that, the estimated coefficient of unexpected trading futures volume is positive and significant at the highest reliable level. This indicates that unexpected futures trading volume has positive and significant effect on stock market volatility (Yilgor & Mebounou, 2016)

As findings from (Siopis & Lyroudi, 2007), to compare the volatility of the spot market volatility of the FTSE/ASE-20 before and after the introduction of futures trading, in order to capture the underlying volatility, several GARCH-family models were used such as the GARCH (1,1), the EGARCH(1,1) and the TGARCH(1,1) for the prior and after the onset of futures trading. The results from all the above GARCH models were different for the weekly return series of the FTSE/ASE-20. The results reveal that there is an enormous impact in the spot market volatility of the FTSE/ASE-

20 index after the introduction of futures contracts because of the significance of the coefficient of the dummy with all GARCH family models. Besides, this effect is negative since the dummy variable has negative coefficient. Thus, there is a decrease

on the volatility of the FTSE/ASE-20 after the introduction of futures.

Regarding to the Turkish stock market, Kasman & Kasman (2008) examined the effect of the introduction of BIST 30 index futures on the spot price volatility. By using EGARCH model they found that the spot price volatility has been reduced by the introduction of futures contracts. Çağlayan (2011) also found a drop of the stock market volatility after the introduction of the BIST 30 index futures contracts using

an GARCH(1,1), EGARCH, GJR-GARCH, APARCH model.

2.4.1.2 Impact of futures trading on spot price volatility in developed market countries

Lee and Ohk (1992) examined the effect of the introduction of the futures trading on the volatility of the market in Japan, Hong Kong, the UK, the USA and Australia. Except for the markets of Australia and Hong Kong, they concluded that the volatility of the stock market increased after the introduction of futures trading.

Kamara et al. (1992) supported the proposition that the beginning of futures market trading destabilizes the spot market by increasing the volatility by examining the S&P500 index in the US market. Chang et al. (1995) used the same methods and concluded that there is an upward trend in volatility only at the end of the futures

market and especially in the last 15 minutes. (Butterworth, 2000), found also that derivatives can cause destabilization of the spot market and that volatility increased for the FTSE Mid 250 index in the UK market which is one of the most developed derivatives market over the world.

In contrast to the above studies that suggested that the futures markets are responsible for the increased volatility of the underlying spot markets, other studies reached the conclusion that the volatility in the post-futures period, the period after the introduction of derivatives, is went down relatively to the volatility of the pre-introduction period. Edwards (1988) after detecting the introduction of S&P500 futures contracts, he found that this is justified for the reduced volatility in the after introduction period. Brown-Hruska and Kuserk (1995) examined the volatility of the S&P500 index after the introduction of stock index futures markets and found that futures markets decrease the stock market volatility

Ultimately, some empirical studies provide evidence that the introduction of futures trading on stock index had no significant impact on the volatility of the underlying market. The details of those studies are presented below:

Spyrou (2005), investigated the impact of the index futures contracts on the Greek spot market volatility. Using an EGARCH and GARCH models, they found that futures contracts has no effect on the spot market volatility. Sathya (2009) also found that the NSE index futures contracts did not influence the Indian spot market volatility. Gökbulut et al., (2009) observed that the introduction of the BIST 30 index futures contracts, has no significant impact on the spot market volatility. Xie and Huang (2014), found also the same evidence after examined the impact of the futures contracts on the China stock exchange.

In line with the findings for the U.S. market, Bacha and Vila (1994) confirm the stabilization hypothesis for the Japanese market, Reyes (1996) for markets in France and Denmark and Dennis and Sim (1999) for the Australian market. On the

other hand, Yu (2001) reports that the volatility of stock returns in the United States, France, Japan and Australia rose significantly subsequent to the introduction of the respective index futures but not in the United Kingdom and Hong Kong

Maberly et al. (1989), Lockwood and Lim (1990) discovered that the volatility

in the spot market increased because of the introduction of futures trading. Brorsen (1991) reached the similar result and he found that volatility was higher after the futures entered the stock markets. Yu (2001), by using a changing GARCH(1,1)-MA(1) model, for the US, French, Japanese, Australian, the UK and Hong Kong markets, found slightly distinguished results. For the markets of the USA, Australia and France, he found that the underlying spot market volatility increased, similarly with the previously mentioned studies.

Further tested with the EGARCH whether there is a presence of leverage effect

on the spot market volatility, after the introduction of futures contracts. The results reveal a presence of the spot market volatility, in other words bad news flowing in the market, increase the volatility more than the good one. This can be explained by the fact that investors overreacted to bad news more than good news. Besides, we investigated whether the futures market trading volume affect the spot price volatility.Using both GARCH and EGARCH model, the study examines the effect of the expected and unexpected BIST-30 index futures trading volume on the underlying spot market. In our test, EGARCH has been found to be the best model to estimate the volatility. Results show that there is no significant impact of the expected futures trading volume in the spot price volatility Sathya (2009)

Using an ARMA model, Sathya (2009) test whether the inclusion of BIST-30 index futures lead to an increase or a decrease of the spot market trading volume.Their results show there is no statistically significant difference of the level of the spot market trading volume after the introduction of futures markets. The reason of

this behavior is not high level of trading volume in the Turkish derivatives market and those markets do not have impact of the spot market trading volume.

2.4.4. General approaches in previous studies

There is a variety of approach that capture the volatility of the spot market and

to determine the optimal methodology to make the estimation Especially with the introduction of futures trading, researchers have to make effort and try to apply some methodologies in the complicated context

2.4.4.1 Determination the impact of futures trading on spot price volatility

In general previous studies have the same common methodology to address

the issue of existence of futures’ effect Siopis (2007) has included a dummy variable

which takes the value 0 for the pre-introduction period and the value 1 for the period after the introduction of futures and tested the significance and the value of this

dummy He also execute this modelling with dummy variable with both GARCH and EGARCH The results indicate that there is a great impact in the spot market volatility

of the FTSE/ASE-20 index after the introduction of futures contracts because of the significance of the coefficient of the dummy with all GARCH family models

Similarly, (Antoniou & Holmes, 1995) and (Butterworth, 2000) carry out the estimation with the model including the dummy variable showing that the strong persistence and reliability in this methodology It can be confirmed again in the study (Bohl, Diesteldorf, & Siklos, 2015), he also supposed that the additive inclusion of the dummy variable in captures possible changes in the overall level of the variance due to the introduction of index futures

Unlike the previous approaches, Bae (2004) determine the impact of futures introduction by employing four factors as independent variables to control for variations in spot price volatility related to firm-specific factors, he estimate the following cross-sectional regression model to measure the mean difference between two periods for the KOSPI 200 stock

𝑆𝑇𝐷𝐼 = 𝛼0+ ∑3𝐽=1𝛼1𝐷𝑇𝑗+ 𝛼2𝑆𝑌𝑅𝐼𝑆𝐾𝑖+ 𝛼3𝐹𝑆𝐼𝑍𝐸𝑖+ 𝛼4𝐼𝑁𝑉𝑃 + 𝛼5𝐹𝑋𝑅𝐼𝑆𝐾𝑖+ 𝑣1 Where STDi is the return (log price relative) standard deviation of stock I expressed

as a daily rate Of the four control variables, SYSRISK represents systematic risk of each stock in the sample, measured by the absolute stock beta multiplied by the standard deviation of market return The stock beta is computed using the equally weighted KOSPI data FSIZE is the natural logarithm of a firm’s market value, measured by stock price multiplied by the number of common shares outstanding NVP is the inverse stock price level and is included to capture price volatility that may be associated with bid/ask spreads INVP is measured as the square root of the average inverse squared price The last control variable, FXRISK, represents foreign exchange rate exposure of a Korean stock in the sample, measuring the effect of foreign exchange rate changes on stock returns The regression model as Bea used can be captured the on spot price volatility but just applicable for sample enterprises (Bae, Kwon, & Park, 2004)

2.4.4.2 Determination how spot price volatility has been impacted in two

sub-period

Table 2.1 Some typical previous research with GARCH Family models

Source: Author’s synthetic

Sathya (2009) indicate that for the pre- and the post-futures model are candidates for an I-GARCH specification Dickey-Fuller tests were carried out on the two models to test for an I-GARCH specification The tests revealed that whilst the pre-futures sample was integrated the post-futures sample was stationary This observation implies that the persistence of shocks has decreased since the onset the derivative trading To determine whether volatility has been substantially reduced in the post-futures sample suggesting that spot returns volatility is less important in explaining spot returns after the advent of futures trading in NSE Nifty index we used

Siopis & Lyroudi 2007 Greece - FTSE/ASE-20Bologna P & Cavallo, L 2002 Italy – FTSE MIB

250 EGARCH Yilgor & Mebounou 2016 Turkey – BIST 30

Siopis & Lyroudi 2007 Greece - FTSE/ASE-20GJR-GARCH

TGARCH

Gulen and Mayhew (2000) 2000 United State and Japan –

International equity Siopis & Lyroudi 2007 Greece - FTSE/ASE-20

250 AR-GARCH Siopis & Lyroudi 2007 Greece - FTSE/ASE-20

the GARCH and EGARCH models to know which model is appropriated to our times series These results indicated that the EGARCH model provides the best fit of the stylized fact of stock returns That is why he choose the EGARCH model to investigate the effects of futures trading activity (volume) on spot market volatility

In term of another point, (Butterworth, 2000) was trying to apply and diversify the methodology to capture the asymmetric phenomenon on the market which draw the attention and motivation for the further research With the traditional perception that assumption the symmetric response to news, he supposed that these assumption could not cover and reflect the volatility of the spot market fully Thus, the GJR model can help to test for the presence of asymmetries are reported for each of the two sub-periods

Using an EGARCH, Yilgor & Mebounou (2016) firstly investigate whether there is a change on the spot price volatility before and after the introduction of BIST-

30 index futures. The evidence suggests that the introduction of futures contracts had caused a significant decrease of the spot price volatility. One reason of this stabilization effect is an increase of the level of available information of participants, and the speculation activity that migrates from the spot to the futures market.EGARCH has been found to be the best model to estimate the volatility. Results show that there is no significant impact of the expected futures trading volume in the spot price volatility. However, when an unexpected futures trading volume took place in the market place, there is an increase of spot price volatility.

The main idea behind in the (Siopis & Lyroudi, 2007) study is to compare the volatility of the spot market volatility of the FTSE/ASE-20 before and after the introduction of futures trading. For this purpose, in order to capture the underlying volatility, several GARCH-family models were used such as the GARCH(1,1), the EGARCH(1,1) and the TGARCH(1,1) for the periods before and after the futures