There is extensive empirical research on the potential destabilizing effects of futures trading activity on spot market volatility. Rather than just focussing on spot volatility, this paper deals with the contemporaneous relationship between futures trading volume and the overall probability distribution of spot market returns. To disentangle the potential destabilizing effect of futures trading activity from cross-interactions due to price discovery process, futures volume is broken down into two drivers: expected and unexpected trading activity. Then, a non-parametric approach is used to estimate the density function of spot return conditional to both spot and futures trading volume. Empirical evidence using intraday data from the Spanish stock index futures market over the period 2000-2002 is provided. Our empirical findings can be summarized as follows: i) spot market volatility is positively related to spot trading volume, ii) for any given spot trading volume, a significant and positive relationship between unexpected futures trading activity and spot volatility is detected; however no significant relationship arises when expected futures trading volume is considered. These findings are consistent with theoretical models predicting that futures trading activity is not a force behind irrational spot price fluctuations.
Muñoz et al. (Wed,) studied this question.