Effects of index option introduction on stock index volatility: a procedure for empirical testing based on SSC-GARCH models

Informed migration, uninformed migration and improved information are the three main potential effects of derivative introduction that, alone or combined, may generate significant changes on volumes, bid-ask and volatility on the underlying asset. Some combinations of these three effects are highly likely to generate observational equivalence making it quite difficult to identify their relative impact in the empirical evidence. This paper aims to provide a marginal contribution to the identification of the prevalent effect by devising an implemented (SSC-GARCH) measure of volatility which evaluates changes in excess reaction to shocks before and after index option introduction in six different countries. The paper finds that the introduction of stock index options: (i) significantly reduces the impact of negative (and, to a lesser extent, positive) shocks on conditional volatility in five out of six countries, (ii) has no significant impact on relative unconditional volatility of stocks belonging to the optioned index in four out of six countries. These results seem compatible with a joint realization of the uninformed migration and the improved information effects.