How Have Contracts for Difference Affected Irish Equity Market Volatility?

Abstract

Contracts for Difference (CFDs) have existed for less than twenty years and the market has grown significantly up to the period before the recent international crises. This paper presents an analysis of how CFDs have affected equity market volatility in Ireland. EGARCH models are used to uncover volatility changes in the periods before and after the introduction of the new trading product in Ireland. We find that CFDs appear to have lowered asset-specific volatility across the majority of equities traded on the Irish Stock Exchange. These findings do not correspond to the expected volatility increase associated with leveraged products that are closely associated with high frequency trading. Our empirical analysis suggests that CFDs are having an alternative volatility reducing effect through the presence of bid and ask price “overhangs” that are generated through the hedging practices of CFD brokers. A fully worked example of the development of an “overhang” is provided.