The impact of the introduction of future contracts on spot contracts volatility for the oil market

Abstract

The introduction of future contracts since 1970 had a major impact on spot market volatility which remains a debatable issue in the market for almost every commodity. One of the major markets that faces many fluctuations and disturbances whether it is economic, political, or financial aspects is the oil sector. This project addresses mainly two issues: the ability to identify the existence of this impact (i.e., effect of futures markets) on the volatility of spot markets, and the nature of this impact. We study these issues by using different econometric methods and test, mainly GARCH, EGARCH and augmented GARHC/EGARHC models by the volume and open interest of these contracts. Five contracts from the oil market are used. After estimating the different models, it appears that there was an impact on the spot market volatility caused by the introduction of future contracts. However, this impact is found to be positive or negative, depending on the methods and tests used. Augmenting the GARCH models by the volume as a factor in the variance equation, we reach similar results. Our results should be useful for commodity market traders, asset managers and investment bankers who base many of their decisions on the relationship between spot and futures markets and on their proper assessment of market volatility for these commodities.