How have contracts for difference affected Irish equity market volatility?

Abstract

Contracts for Difference (CFDs) have existed for less than twenty years and the markethas grown significantly up to the period before the recent international crises. This paper presentsan analysis of how CFDs have affected equity market volatility in Ireland. EGARCH models areused to uncover volatility changes in the periods before and after the introduction of the newtrading product in Ireland. We find that CFDs appear to have lowered asset-specific volatilityacross the majority of equities traded on the Irish Stock Exchange. These findings do notcorrespond to the expected volatility increase associated with leveraged products that are closelyassociated with high frequency trading. Our empirical analysis suggests that CFDs are having analternative volatility reducing effect through the presence of bid and ask price overhangs thatare generated through the hedging practices of CFD brokers. A fully worked example of thedevelopment of an overhang is provided.