ABSTRACT

This chapter examines the impact of program trading on the daily volatility of the Standard & Poor (S&P) 500 cash and the S&P 500 futures returns for the period January 1988 to December 1991. It shows that while the aggregate program trading volume increases the volatility of the S&P 500 cash and futures returns, individually buy and sell programs have quite different effects. The chapter provides a brief discussion of the existing empirical research on the effects of program trading. It proposes a bivariate generalized autoregressive conditional heteroskedasticity model and discusses the results. With the development of derivative securities such as financial futures, options and options on futures, investment strategies have become increasingly innovative, requiring sophistication in the manner in which these strategies are regularly monitored and executed. Program trading is one such innovation which includes stock index arbitrage, portfolio insurance and index substitution. The link between program trading and the market volatility is straightforward.