DETERMINANTS OF SET 50 INDEX FUTURES PRICE

VOLATILITY: EVIDENCE FROM THE THAILAND FUTURES

EXCHANGE TFEX

Project for: Financial Engineering and Risk Management

Submitted by Kamal Saeed

ID 5719580
ABSTRACT:
This paper examines the effects MIXED distribution hypothesis MID
proposed by Clarke (1973) where information is proxies by volume and
open interest on the price volatility of futures contracts in TFEX derivative
markets. The determinant of volatility is tested using conditional variance
models during the period from January, 215 to Jan 2016. . Empirical results
show that volume and open interest will impact or not significantly the
volatility of futures contracts. If is found that as during end of contract, and
it showed presence of Mixed Distribution Hypothesis which means
information flow has certain impact on settlement price of SET 50 Index
during maturity.

Approaches to maturity set 50 index contracts the volatility increases.

Furthermore, a positive correlation is found between the price volatility of
futures contracts and volume, whereas volatility and open interest are
found to correlate negatively. Mixture of Distributions Hypothesis are
supported in Thailand derivative markets specially in set 50 index Thailand.
This research studies determinants of SET 50 Index futures price volatility
in Thailand Futures Exchange using generalized autoregressive conditional
heteroskedasticity model also comparing with Exponential Autoregressive
conditional Heteroskedasticity. The sample data consist of daily closing
price, volume, and open interest of silver futures from the for the nearby
month contract with sample data points. I will construct data sample by
switching or rolling over to the next maturing contract one day before the
expiration date. I want to see relationship between Volume and a positive
role for open interest in determining SET 50 Index futures price volatility.
The analysis of SET 50 Index futures price volatility might insists the
Clearing House that margin requirements for silver futures should not be
affected as the time to maturity of the contract decreases. The findings
will benefit and helpful to risk managers dealing with SET 50 Index
futures and predicting SET 50 Index futures price volatility.
 Chapter 1
Introduction
Derivatives products such as forwards, futures, and options are great tools,
which investors can use to predict future spot prices and minimize their
risk. Derivatives in Thailand have started long before Thailand Futures
Exchange (TFEX) came into existence. Usually they are in the form of an
over-the-counter between each counterparty. On May 17, 2004, TFEX, a
subsidiary of the Stock Exchange of Thailand (SET), was established as a
derivatives exchange. TFEX has traded SET50 index futures, SET50 index
options, gold futures, silver futures, interest rate futures, single stock
futures, crude oil futures, USD futures, and sector futures since then. In
2013, TFEXs average daily volume was 68,017 contracts, 55.21% more
than the 43,823 in the previous year. About 99.61% of the 2013 derivatives
trading were futures. Before trading futures in TFEX, investors are required
to deposit initial margin with their respective brokers to ensure that they
fulfill their futures contract obligations. Initial margin requirements for
futures contracts are set by Thailand Clearing House Co., Ltd. (TCH). Their
required rates are the same on the same underlying across different
maturities and typically only 10 to 15 percent of the full value of the futures
contracts. At the end of day, brokers will calculate the profit and loss and
add or subtract funds via a Mark-to-Market process. If the balance in the
margin account falls below the maintenance margin level, investor will
receive a margin call to top up his or her margin account to meet the initial
margin requirement. One of the important factors affecting margin rate is
futures price volatility. Therefore, understanding and characterizing futures
price volatility has been a key issue in futures market research. Previous
research has explained futures price volatility by variables such as time to
maturity, volume, and open interest with high and low volume during each
day upto maturity

New Shock or flow of information It is widely referred to as the Mixed

Distribution Hypothesis. The logic behind this conclusion is that the market
is more sensitive to news regarding near-maturity contracts than more-
distant contracts, which is indicated by greater volatility for the near-
maturity contract (Ripple and Moosa, 2009). Numerous studies have
investigated the Samuelson hypothesis empirically, and the hypothesis has
been supported in commodity futures markets (Daal and Farhat, 2004;
Duong and Kalev, 2008; Karali, Dorfman and Thurman, 2009; Karali and
Thurman, 2010) and currency futures markets (Madarassy Akin, 2003).
MID also holds in TFEX gold futures price volatility (Jongadsayakul,
2014b) increase as expiry approaches. However, using GARCH(1,1),
Jongadsayakul (2014a) find the evidence of inverse maturity effect in case
of crude oil futures traded in TFEX. In addition, Chen, Duan and Hung
(1999) find that the volatility of the Nikkei-225 index futures price decreases
when the contract is closer to its maturity.

Volatility is the main variable used when pricing futures contracts,

determining the margin amount, and managing risk. Knowing the volatility
course as maturity approaches ensures correct estimation of the settlement
price and, related to this, the correct holding position. In futures contracts,
collateral amounts requested by clearing houses also correlate positively
with the volatility of futures contracts (Pati and Kumar, 2007). Within the
literature, conclusions and sign vary as to whether the main determinants
of volatility in futures contracts are time to maturity, volume or open
interest. The relationship between volatility and time to maturity (TTM) has
been tested in a number of countries using a variety of underlying assets.
While some of these studies found a negative relationship between
volatility and time to maturity, others revealed positive or no relationship
(Rutledge, 1976; Miller, 1979; Castelino, 1982; Anderson, 1985; Milonas,
1986; Galloway and Kolb, 1996; Beaulieu, 1998; Walls, 1999; Garcia and
Alvarez, 2004; Doung, 2005; Verma and Kumar, 2010; Karali and
Thurman, 2010; Kenourgios and Ketavatis, 2011; Gurrola and Herrerias,
2011 and Kadioglu and Kili, 2015.) The other determinants of volatility,
volume and open interest, have been tested by Grammatikos and
Saunders (1986); Khoury and Yourougou (1993); Walls (1999),
Bessembinder and Seguin (1993); Pati and Kumar (2007), Kalayci, et al.
(2010); and Kenourgios and Ketavatis (2011). Some of these studies have
found a positive relationship between volatility and volume, while others
have found no relation.

This study is the first to try to find out determinant of price volatility in THAI
derivative markets. The study utilizes Price return , trading volume and
open interest are used as explanatory variables and the exponential
generalized autoregressive conditional heteroskedasticity (E-GARCH)
model and also GARCH (1,1) model . The study analyzes futures contracts
traded on markets that are backed by dollar, Euro and gold currencies;
Borsa Istanbul Indices and single shares traded on Bursa Istanbul. Futures
backed by agricultural products are not included in this study, as they are
either not traded or traded in a very limited capacity on these exchanges.
Along with the model and method used, this study contributes to the
literature through to its longer period of analysis, the inclusion of data from
two different markets and the examination of futures backed by different
types of underlying assets.

Futures trading activity proxy by volume and open interest is another

important determinant of futures price volatility. Numerous works have
examined the relationship between trading volume and futures price
volatility. Considerable evidence exists a positive correlation between
futures price volatility and trading volume (Madarassy Akin, 2003; Xin,
Chen and Firth, 2005; Kuo, Hsu and Chiang, 2005; Pati, 2006; Ripple and
Moosa, 2009; Jongadsayakul, 2014a, 2014b); however, Bessembinder and
Seguin (1993) suggest that the volatility-volume relationship might depend
on the type of trader. Daigler and Wiley (1999) find that the public drives
the positive volatility-volume relationship whereas trades by clearing
members and floor traders often exhibit an inverse relationship between
volatility and volume. Moreover, Avramov et al. (2006) show that informed
trades lead to a reduction in volatility while non-informational trades lead to
an increase in volatility. The introduction of open interest as an additional
explanatory variable is motivated by the fact that open interest and its
change differ significantly from trading volume. The expectation is that
open interest is negatively related to volatility (Xin, Chen and Firth, 2005;
Feng and Chuan-zhe, 2008; Ripple and Moosa, 2009; Jongadsayakul,
2014b), as the availability of more contracts represents increased market
depth, implying greater liquidity. However, Madarassy Akin (2003) and Pati
(2006) find the positive relationship between open interest and financial
futures price volatility. Higher open interest means that there are more
future trade expected and more opportunity for the prices to move into
higher or lower levels. This implies an increase in current futures price
volatility. Relationship between volatility and time to maturity, volume and
open interest continues to be discussed in a number of studies.

This paper therefore examines the relationships between silver futures

price volatility, time to expiration, trading volume, and open interest in
TFEX using Generalized Autoregressive Conditional Heteroskedasticity
(GARCH) model. The results from the MA(1,7,15)-GARCH(1,1) model
reveal there is no significant relationship between volatility and time to
expiration. Silver futures price volatility is or not negatively related to trading
volume and positively related to open interest. The analysis of silver futures
price volatility want to find whether TCH that margin requirements for silver
futures should not be or be affected as the time to maturity of the contract
decreases. The findings will also be helpful to risk managers dealing with
silver futures and predicting silver futures price volatility. Moreover, it adds
to literature as another evidence of a if there is negative role for trading
volume and a positive role for open interest in determining silver futures
price volatility, which are not as expected but after the result it will be
prominent or not that what we would like to seek out for.
 Chapter 2
Literature Review

The literature contains numerous studies attempting to identify the

important variables that influence futures price The Mixed Distribution
Hypothesis has been empirically supported in commodity futures markets
(Daal and Farhat, 2004; Duong and Kalev, 2008; Karali, Dorfman and
Thurman, 2009; Karali and Thurman, 2010) and currency futures markets
(Madarassy Akin, 2003) gold futures price volatility (Jongadsayakul,
2014b). However, Chen, Duan and Hung (1999) find the inverse maturity
effect in the Nikkei-225 index futures price volatility. Other studies also
show that their results depend on the data and the methodology.

Ripple and Moosa (2009a) stated that the market is more sensitive to news
regarding near maturity contracts than more-distant contracts is indicated
by greater volatility for the near-maturity contract News Affect Proxies by
Volume and Open interest supported by (Ripple and Moosa,
2009).(Maddrassy Akin 2003: Akin 2003,Xin,chen firth 2005 and
Jongadsayaklul 2014a and 2014b).

Floros and Vougas (2006) find that the Samuelson hypothesis seems to be
correct in simple linear regressions for both FTSE/ASE-20 and FTSE/ASE
Mid 40 index. On the other hand, using GARCH models, there is no
evidence to support MID Hypothesis in FTSE/ASE-20 index over the whole
period. However, using monthly series, GARCH models show a stronger
support to the Samuelson hypothesis rather than linear regressions.
Moreover, Jongadsayakul (2014a) shows that there is no significant
relationship between crude oil futures price volatility and time to expiration
in linear regression model while there is an evidence of inverse maturity
effect in GARCH(1,1) model. Futures trading activity proxies by volume and
open interest is another important determinant of futures price volatility.
When trading volume increases, it increases the probability that prices will
move into higher or lower regions, and that their volatility will be greater
than before (Xin, Chen and Firth, 2005). On the other hand, trading volume
can be used as a measure of the information flow. Therefore, when new
and unexpected information arrives, both volatility and volume change
contemporaneously and positively to new information. Numerous works
identify a strong positive relation between price volatility and trading
volumes (Madarassy Akin, 2003; Xin, Chen and Firth, 2005; Kuo, Hsu and
Chiang, 2005; Pati, 2006; Ripple and Moosa, 2009; Jongadsayakul,
2014a, 2014b). However, Bessembinder and Seguin (1993) suggest that
the volatility-volume relationship might depend on the type of trader Daigler
and Wiley (1999) find that the public drives the positive volatility-volume
relationship whereas trades by clearing members and floor traders often
exhibit an inverse relationship between volatility and volume. Moreover,
Avramov et al. (2006) show that informed trades lead to a reduction in
volatility while non-informational trades lead to an increase in volatility.
Besides trading volume, open interest is important indicator of trading
activity. It reflects the current willingness of futures traders to risk their
capital in the futures position, which indicates the level of market depth
(Bessembinder and Seguin, 1993). A high level of open interest could help
to create market conditions that would reduce pressure from prices when
trading provides new information (Xin, Chen and Firth, 2005). Several
studies find that open interest is negatively related to volatility (Xin, Chen
and Firth, 2005; Feng and Chuan-zhe, 2008; Ripple and Moosa, 2009;
Jongadsayakul, 2014b). However, Madarassy Akin (2003) and Pati (2006)
find the positive relationship between open interest and financial futures
price volatility. Higher open interest means that there are more future trade
expected and more opportunity for the prices to move into higher or lower
levels. This implies an increase in current futures price volatility.

Clark (1973). According to MDH, the market reacts to new information, so

information flow creates volatility. At the same time, the rate of information
coming into the market varies according to the lifespan of a give futures
contract. Therefore, it is more likely to be a stochastic process. Due the
fact that this phenomenon cannot be monitored precisely, trading volume
and open interest are used as proxies for information flow. Bessembinder
and Seguin (1993) also argued that one of the main determinants of price
volatility in futures contracts is trading activity (volume and open interest).
Anderson and Danthine (1983) argued that one of the main determinants of
volatility is TTM. They suggest that this is due to a lack of clarity in
information reaching the market about the underlying assets. The amount
of information about the underlying assets increases as maturity
approaches; therefore, the volatility of futures contracts also increases.
Bessembinder and Seguin (1993) also argued that price volatility is
positively related to trading volume, but negatively related to open interest.

Cruickshank (2000), Verma and Kumar (2010), Kalev and Doung (2008),
Karali and Thurman (2010), Gurrola and Herrerias (2011), Kenourgios and
Ketavatis (2011) and Kadioglu and Kili (2015) all found a negative
relationship between volatility and TTM. On the other hand, Rutledge
(1976), Khoury and Yourougou (1993), Galloway and Kolb (1996), Walls
(1999), Arago and Fernandez (2002) found a negative relationship between
volatility and TTM. Grammatikos and Saunders (1986), Khoury and
Yourougou (1993), Kenourgios and Ketavatis (2011), Bessembinder and
Seguin (1993), Pati and Kumar (2007), Kalayci, et al. (2010) and
Jongadsayakul (2015) found a positive relationship between volatility and
volume, whereas Walls (1999) did not. Bessembinder and Seguin (1993),
Pati and Kumar (2007) and Kenourgios and Ketavatis (2011) found a
positive relationship between volatility and open interest the results are
inconclusive as to whether or not volatility relates negatively to TTM and
open interest, or whether it relates positively to volume and volatility.

Futures trading activity proxied by volume and open interest is another

important determinant of futures price volatility. When trading volume
increases, it increases the probability that prices will move into higher or
lower regions, and that their volatility will be greater than before (Xin, Chen
and Firth, 2005). On the
other hand, trading volume can be used as a measure of the information
flow. Therefore, when new and unexpected information arrives, both
volatility and volume change contemporaneously and positively to new
information. Numerous works identify a strong positive relation between
price volatility and trading volumes (Madarassy Akin, 2003; Xin, Chen and
Firth, 2005; Kuo, Hsu and Chiang, 2005; Pati, 2006;

Ripple and Moosa, 2009; Jongadsayakul, 2014a, 2014b). However,

Bessembinder and Seguin (1993) suggest that the volatility-volume
relationship might depend on the type of trader.

The MID (Mixed distribution Hypothesis) theory explaining the relationship

between volatility and trading activity (volume and open interest) is the
Mixture of Distribution Hypothesis (MDH) proposed by Clark (1973).
According to MDH, the market reacts to new information, so information
flow creates volatility. At the same time, the rate of information coming into
the market varies according to the lifespan of a give futures contract.
Therefore, it is more likely to be a stochastic process. Due the fact that this
phenomenon cannot be monitored precisely, trading volume and open
interest are used as proxies for information flow. Bessembinder and Seguin
(1993) also argued that one of the main determinants of price volatility in
futures contracts is trading activity (volume and open interest).

Anderson and Danthine (1983) argued that one of the main determinants of
volatility is TTM. They suggest that this is due to a lack of clarity in
information reaching the market about the underlying assets. The amount
of information about the underlying assets increases as maturity
approaches; therefore, the volatility of futures contracts also increases.
Bessembinder and Seguin (1993) also argued that price volatility is
positively related to trading volume, but negatively related to open interest.
 Chapter 3
Data Methodology and Conceptual Framework

This study examines determinants of SET 50 Index futures price

volatility by using daily data downloaded from the websites of
Thomson Reuters and TFEX.

sample data consist of daily closing price, time to maturity, trading

volume, and open interest of silver futures from the period June 1ST ,
2015 to 31st JAN 31ST 2017 with 455 data points

I construct data sample by switching or rolling over to the next

maturing contract one day before the expiration date.

To analyze the volatility of SET 50 INDEX futures price, I employ

Exponential Generalized Autoregressive Conditional Heteroskedasticity
(EGARCH) also comparing with GARCH methodology. Based on Akaike
Information Criterion (AIC) and Schwarz-Bayes Criterion (SBC), a GARCH
(3,3) and EGARCH (5,5)model is
The price of future may go up or down due to volume or open interest
outstanding, this price pressure push the price up and down causes volatility to
preexist in TFEX market, which we intend to capture.
 GARCH (Jongadsayakul, 2014b) specification is augmented by
FUTURE volatility with two trading activity variables, open interest
and trading volume, in order to determine their relative contribution to
the conditional variance. The following model is then estimated to
investigate SET 50 INDEX futures price volatility in TFEX.

This study utilizes E-GARCH models to find the main determinant of price
volatility of future contracts in Thai SET 50 Index Future Derivatives
market..

The generalized autoregressive conditional heteroskedasticity (GARCH)

model was initially proposed by Engle (1982) and further developed by
Bollerslev (1986). The GARCH models take into consideration volatility
clustering and conditional variances, which are determined by information
(error terms) from the past. GARCH models also allow for the existence of
time-varying volatility. Share prices respond to negative information more
than positive information, and the standard GARCH model is unable to
capture this asymmetric information flow. Other problems with the standard
GARCH model are possible violation of non-negativity constraints by the
estimated models and the fact that it does not allow for direct feedback
between the conditional variance and conditional mean (Brooks, 2008).
Due to problems with the standard GARCH model, the exponential GARCH
model (E-GARCH), developed by Nelson (1991), has been proposed 110
Eyp Kadiolu et al.

EGARCH

E-GARCH models used to find a relationship between volatility volume and open
interest (Kenourgios & Ketavatis, 2011; Pati and Kumar, 2007). E-GARCH (1,1)
models are chosen by taking into consideration Akaike Information Criteria and
Schwarz Criterion.

1. Q Stat 36 lag test, are used to find there is no serial correlation exist to
show that model is efficient.

2. OLS Regression is used.

3. EGARCH and GARCH used to find impact of volatility captures most by
which Model.
 Chapter 4
Test and Results
Here we go through step by step using the data into EVIEW version 7 and
conclude if there is a impact of MID exist in TFEX market Thailand.

1. We would use Unit root test to see the data do not consist any non-
stationary data.
2. After checking unit root test in each variable we would test OLS
regression to find the impact of variable.
3. We would check for Serial correlation test using Godrefy test if there
is no serial correlation than the model is well fitted to use.
4. We would check if there is no left over ARCH effect left using ARCH-
LM test using 4 lags.
5. We would use GARCH and EGARCH model and find the best model
by checking Schwarz Criterion with lowest value.
6. Check the best model for GARCH and EGARCH.
7. Conclude the result and conclude if GARCH and EGARCH captures
perfect Mixed Distribution Hypothesis exist in Thai Derivative Market.
UNIT ROOT TEST: SET 50 INDEX

Tstat is insignificant data needs to be stationary using lag of Set 50.

Volume :
Openinterest:

Time to maturity: TTM

GARCH (3,4) Log Var

GARCH (3,3) (Logvar)

GARCH (3,3) Log Var best model showing significant relationship with volume
open interest and time to maturity.

QSTAT correlations hip shows no correlations hip so model is well behaved, prob
is not significant

ARCH LM TEST: Shows no ARCH Effect is left.

From GARCH (3,3) model it shows SET 50 Index has significant
relationship with Time to maturity, openinterest and volume but it shows
more open interest reduces volatility of future spot price and return.

It Shows MID (Mixed Distribution Hypothesis exists) with Thai Future 50

Index prevails, which the model GARCH (3,3) Log var shows prevailing
relationship with Positive reltionships with Time to maturity and volume,
higher volume and more closer the maturity the volatility increases, with
more higher openinterest the volatility has negative coefficient shows
volatility decreases as more open interest exist in Thai set50 Index.

EGARCH model (5,5)

The generalized autoregressive conditional heteroskedasticity (GARCH)
model was initially proposed by Engle (1982) and further developed by
Bollerslev (1986). The GARCH models take into consideration volatility
clustering and conditional variances, which are determined by information
(error terms) from the past.

GARCH models also allow for the existence of time-varying volatility. Share
prices respond to negative information more than positive information, and
the standard GARCH model is unable to capture this asymmetric
information flow. Other problems with the standard GARCH model are
possible violation of non-negativity constraints by the estimated models and
the fact that it does not allow for direct feedback between the conditional
variance and conditional mean (Brooks, 2008). Due to problems with the
standard GARCH model, the exponential GARCH model (E-GARCH),
developed by Nelson (1991), has been proposed as an alternative in the
finance literature. E-GARCH articulates conditional variance as an
asymmetric function of past errors

EGARCH (5,5) BEST MODEL depends on significant relationships with

Volume, Time to Maturity and Open interest.
EGARCH failed to show any relationships with Volume but shows positive
relationships with open interest but surprisingly it shows negative
relationships as contract reaches maturity coefficient shows negative -0.55
which means as contracts nears maturity volatility decreases but as
contracts reaches maturity positive relationships higher open interest
means higher volatility just the opposite which was captures in GARCH
(3,3) model, which shows surprisingly different method of GARCH and
EGARCH shows different results although EGARCH has been proposed
before by Clarke (1973) that EGARCH shows better capture of volatility but
in my test I can see that GARCH (3,3) has better capture of volatility trend
with time to maturity, volume and open interest.

EGARCH(5,5) shows no serial correlation the model is best behaved. No

prob shows any significant relationships.

ARCH LM TEST: 4 lags has been used and shows no ARCH effect is left
 CHAPTER 5

Conclusions

This research studies determinants of SET50 index

futures price volatility in Thailand Futures Exchange using
the GARCH (Log var (3,3) EGARCH(5,5) model. The
sample data consist of daily closing price, volume, and
open interest of silver futures from the period June, 2015
to march 26, 2017 for the nearby month contract with 469
sample data points. I construct data sample by switching
or rolling over to the next maturing contract one day before
the expiration date. The results from the GARCH(3,3)and
E-GARCH(5,5) model reveal there is significant
relationship between SET 50 futures price volatility and
time to expiration, also trading volume and open interest
tend to be significant. However, the signs of open interest
coefficients are not as expected. The results indicate a
negative relationship between SET 50 Index futures price
volatility and trading volume, and negative relationship
between SET 50 Index futures price volatility and open
interest. Therefore, time to maturity ,trading volume and
open interest are three important variables showed in
GARCH (3,3) model but in EGARCH (5,5) shows only time
to maturity and open interest only two explanatory
variables, explaining the price volatility of SET 50 futures
traded in TFEX.
Since margin requirement is affected by futures price
volatility, the results of this study will assist TCH in setting
margin requirements. No consistent relationship between
SET 50 Index futures price volatility and time-to-maturity
indicates that the margin requirement should be affected
as the time-to-maturity of the SET 50 Index futures
contract decreases. The findings are also helpful to risk
managers dealing with SET 50 Index futures and
predicting SET 50 Index futures price volatility. It is noted
that the role of trading volume on SET 50 Index futures
price volatility is positive. The inverse relationship between
open interest and time to maturity in GARCH (3,3) model
and only open interest and time to maturity is prevalent in
EGARCH (5,5) model which is surprising two different
method of volatility shows two different results his study
uses total volume. Therefore, further analysis of this issue
should include both informed trades and non-informational
trades to confirm the results. Also different methodology
and further TGARCH should be employed to see the effect
of volatility how the test results shows in intra trade trading
in SET 50 Index Futures in Thailand derivatives market.
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