The Impact of Derivatives on Cash Market

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The Impact of Derivatives on Cash Markets: What Have We Learned? Stewart Mayhew Department of Banking and Finance Terry College of Business University of Georgia Athens, GA 30602-6253 October 27, 1999 Revised: February 3, 2000 The Impact of Derivatives on Cash Markets: What Have We Learned? Abstract This paper summarizes the theoretical and empirical research on how the introduction of derivative securities affects the underlying market. A wide array of theoretical approaches has been applied to the question of how speculative trading, the introduction of futures, or the introduction of options might affect the stability, liquidity and price informativeness of asset markets. In most cases, the resulting models predict that…show more content…
Turning to the introduction of option contracts, the non-linear payoff structure of options adds an interesting dimension to the problem, that has inspired much insightful theoretical research. Still, no real consensus has emerged as to whether we should expect options to stabilize or destabilize the underlying market. As in the case for the introduction of futures, the range of theoretical possibilities is sufficiently broad as to accommodate nearly any conclusion, depending on what assumptions are made. Nevertheless, it can be quite instructive to examine this literature carefully, for in doing so we may gain valuable insights to help us gain a richer appreciation of the complicated relationships between derivative and primary assets. The empirical literature on this issue is vast. Studies have been performed on data from commodity, fixed-income, individual stock, stock-index, and currency futures, as well as individual For earlier surveys related to this topic, see Damodaran and Subrahmanyam (1992), Hodges (1992) and Sutcliffe (1997). 1 2 stock stock-index, and currency options, including markets in the United States and in many other nations. Researchers have studied the impact of derivatives by comparing underlying market characteristics before and after introduction dates, by studying the behavior of the underlying market around the expiration dates of the derivative contracts,

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