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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of International Financial Markets, Institutions and Money, Volume 14, Issue 5, December 2004, Pages 491–505
This study examines the daily volatility of four futures contracts on Chinese futures exchanges (copper, mungbeans, soybeans and wheat). We find that returns have asymmetric effects on volatility, meaning that negative returns have a greater effect on volatility than positive returns do. Volume is positively related to volatility, open interest is negatively related to volatility, and the extent of large-volume traders’ participation is also positively related to volatility. We conjecture that the global patterns of volatility relationship, which have become more pronounced in Chinese markets in more recent years, are attributable to the results of ongoing government attempts to achieve transparency and better disclosure.
The Chinese futures markets started trading in 1993. They have seen some tumultuous events in the last 10 years, and they are still evolving. During this period, the Chinese government implemented many regulatory reforms in the governance of its futures markets. While the research findings on the effects of government regulations on futures markets are mixed, the regulations on the futures markets in China are more “general” regulations that focus on the trading environment and general operational structures. These regulations are intended to establish stability and regularity in the trading of these futures contracts, as trading in Chinese futures markets is generally perceived as highly speculative. Pliska and Shalen (1991) provide simulation results in suggesting that extreme margin and position limit regulations are counterproductive. These trading regulations tend to lower volume and open interest in the futures markets. However, Ma et al. (1993), in a study of silver futures, find that timely margin interventions occurring after excessive price jumps actually dampened volatility. In several recent studies, Yang et al., 2001a and Yang et al., 2001b find that the government plays an important role in aligning futures prices with cash prices. The existing literature about the effect of futures regulation focuses more on the trading regulations and the US. markets. The effect of “general” regulations, as in case of the Chinese regulations, upon an emerging futures market is generally unknown. This study examines the volatility behavior of the Chinese futures markets within the context of ongoing China’s general regulations. Chinese regulations on the futures market tend to serve useful functions. First, they attempt to curb excessive speculations by individuals and firms, which inject substantial noises into the futures pricing by spreading rumors and engaging in sporadic trading, causing a wider swing in the futures prices and thus increasing the volatility. Second, these regulations establish an environment whereby market participants can obtain relevant and useful information to make their informed decisions. As a result, futures price can provide a better predictor of the cash price and serve a price discovery function. The information enhancing function of regulations likely reduces excessive volatility. As more and effective regulations are implemented in China in recent years, we expect that these regulations will result in lower volatility than the earlier years and the vicissitudes of futures prices are more likely to respond better to fundamental economic forces. We study the daily volatility behavior of four Chinese futures contracts (copper, mungbeans, soybeans and wheat) on the three exchanges and examine how the volatility is related to fundamental factors in futures trading under the influence of ongoing regulations. The Chinese government understands that effective futures market operation depends in part on the price discovery function of futures prices, which depends in turn on the volatility of the futures market. An examination of the relationships of daily volatility behavior allows us to gauge the impact of the government’s regulatory reforms and sheds some lights on the usefulness of the general regulations for other emerging futures markets. We examine several hypotheses related to daily volatility. We test how the daily volatility of these four futures contracts relate to futures price changes, trading volume, open interest, and the extent of large-volume traders’ participation. Many authors have examined these relationships in other futures markets. First, we test whether volatility is related to returns on futures contracts. The finding of the asymmetric effect of positive and negative returns on futures volatility is largely consistent with research in equity markets (e.g., Pindyck, 1984, French et al., 1987 and Campbell and Hentschel, 1992 and Bekaert and Wu (2000)). The literature on asymmetric volatility responses to equity market returns suggests that a risk premium is the underlying reason. Consider there is a negative shock to the equity market in the form of bad news, resulting in a rise in equity volatility and a drop in equity prices. The risk premium of stocks increases in response to increased equity volatility, reducing equity prices further. A positive shock would result in a rise in the equity price and also a rise in the volatility. The rise in volatility also leads to a rise in the risk premium, which in turn tends to diminish the equity price. This would diminish the initial price increase due to the positive shock. Thus, the volatility response to a positive return is smaller than the response to a negative return.3 Bessembinder and Seguin (1993) examine the relationships among volatility, returns, volume and open interest in major contracts such as currency futures, treasury bill/bond futures and commodity futures contracts. Volume has a positive impact on volatility, while open interest mitigates volatility. Garcia et al. (1986) study the lead-lag relations between volume and volatility in five commodity futures contracts, and find feedback relationships between volume and volatility. Najand and Yung (1991) and Foster (1995), using a generalized autoregressive conditional heteroskedasticity (GARCH) model, find a positive relationship between volatility and trading volume in the Treasury bond futures and crude oil futures markets, respectively. Trading volume is likely to be associated with speculation, since day traders or speculators trade in and out in short periods of time, and seldom hold a position for too long. Hedgers, however, may hold their positions longer. The level of hedging activities, reflected in the open interest of futures contracts, mitigates volatility. Trading volume can also be used as a proxy for information flows, while the open interest variable can be used to proxy market depth. Fung and Patterson (2001) find that volume increases volatility, and open interest reduces volatility in currency futures markets. An interesting characteristic in the Chinese futures market is the potential impact of large-volume traders (who are small in numbers) on the futures price volatility. Liu (2002), using a time-stamped transaction data set, examines the scalping behavior of Chinese soybean futures contracts on Dalian Futures Exchange over a 7-month period during 1999–2000. The transaction data with traders’ information reveal identification of scalpers and large-volume traders. The results by Liu (2002) suggest that the large-volume trading is an important source of futures volatility in the Chinese soybean futures market.4 In light of the above analysis, we examine how futures volatility relates to returns, volume, open interest, and the extent of large-volume traders’ participation over time in the context of ongoing Chinese regulatory changes. Our results enable us to assess whether regulatory changes help align the Chinese futures markets with global patterns of futures price behavior.