Impact of Derivative Trading on Stock Market Volatility: Empirical Evidence from Emerging Markets

Abstract

This study investigated the impact of derivative trading on stock market volatility in emerging markets. We analyzed data from 10 emerging markets over 15 years (2005-2020) using a panel data approach. The research employed GARCH(1,1) models to estimate volatility and conducted difference-in-differences (DiD) analysis to assess the effect of derivative introduction. Additionally, we used Granger causality tests to examine the directional relationship between derivative trading and volatility. Results indicated that introducing derivatives significantly reduced stock market volatility (β = -0.0023, p < 0.01). This effect was more pronounced in markets with higher liquidity (interaction β = -0.0012, p < 0.05) and better regulatory frameworks (interaction β = -0.0015, p < 0.05). Granger causality tests suggested a unidirectional relationship, with derivative trading Granger-causing reduced volatility (F = 7.234, p = 0.002). Furthermore, GARCH persistence analysis revealed decreased volatility persistence post-derivative introduction across all sample markets. These findings contribute to the ongoing debate on the role of derivatives in financial markets and have important implications for policymakers and market regulators in emerging economies.