Causal relationship between speculative activity and spot market volatility

This paper examines the effectiveness of stock index futures by analyzing the dynamic interactions and causal relationship between speculative type activity and spot market volatility. Evidence for bi-directional information flow between speculative activity and volatility are obtained using VAR methodology. It appears that investors speculate in the futures market, in particular when faced with volatility in the cash market. The fluctuations as a result of speculative activity are decreasing over a period of time, possibly due to the hedging activities taking place in the market. The dynamic interactions between speculative activity and spot volatility shows that index futures are having a stabilizing effect on underlying spot market.