Quantifying the Effects of New Derivative Introduction on Exchange Volatility, Efficiency and Liquidity

This thesis investigates the effects of the introduction of new financial derivative products on exchange volatility, efficiency and liquidity. The derivatives under primary investigation are Exchange Traded Funds (ETFs) and Contracts for Difference (CFDs). These products offer a cheap, tax-efficient and speedy method for increasing or decreasing market exposure to price changes in the related primary asset. By facilitating faster and shorter-term trading, these products may increase market liquidity and/or increase market volatility for the related primary asset. The thesis builds a cross-country database of new-derivative-markets opening dates, and investigates the key features of prices and returns for related primary assets before and after the opening of these derivative markets. The database covers 16 countries in the CFD investigation, 21 commodity markets in the ETF investigation, and related data as available (daily closing prices, trading volumes, bid-ask quotes) in each of them. The key price and return features investigated include bid-ask spreads, trading volumes (both of derivatives and related primary assets), and daily return autocorrelation, variance, skewness and kurtosis. This thesis also considers a separate, but related, research problem. It extends and empirically applies a liquidity-indicator model for the Eurozone created by the Bank of England (BOE) and developed further by the European Central Bank (ECB) by including commodity liquidity, and uses this extended model to investigate shifting investor behaviour based on changing market dynamics. Similar to the investigation of the CDF and EFT markets, this investigation is concerned with market stability and liquidity in a changed environment (in this case, the key change is the introduction of the euro currency)