A Study on the Effects of Program Trading on Kospi and Kospi200 Futures Market in Korea

A Study on the Effects of Program Trading on KOSPI and KOSPI200 Futures Market in Korea

Sang-Bum Park Professor, Dept. of Business Administration Korea Aerospace University

Abstract

Vector Autoregressive models' estimation, Granger Causality Test, Imp ulse Response Function, and Forecast Error Variance Decomposition have been conducted to test the dynamic relation among program trading, KOSPI and KOSPI200 futures price. There were three results and implications. Firstly, program trading has increased r elationship with the daily rate of return on KOSPI as well as Kospi200 futures market since 2001. Secondly, the daily rate of return on KOSPI as well as Kospi200 futures market affected program trading. Thirdly, the program trading was influenced by the da ily rate of return on Kospi200 futures market much more than that on KOSPI market. The hypothesis that program trading increased the volatility of KOSPI market was not supported by these results. However Futures market has affected program trading significantly.

Key words: Rate of Return on KOSPI market, Vector Autoregressive models, Granger Causality Test, Impulse Response Function, Forecast Error Variance Decomposition

I. Introduction The volume of program trade amount reached about 35.3% of trading volume by August 2006 in Korea.

Now program trading has emerged as an indicator of stock market trend and change. Generally speaking program trading can affect stock market in two ways. First, program trading can reduce temporary unbalance between spot market and future market, thus make the market more efficiently. Second, program trading may cause market turbulence and unbalance of liquidity, increase market volatility. Overall there is close relationship between program trading and market movement and interaction between them exists as well. In this study, what effects program trading makes to stock market in Korea investigated. Especially we analyzed whether there is significant relation between...