Do newly listed derivatives affect the market risk premium in a thin stock market?

Abstract

This study examines the effects on the stock market unitary risk premium and volatility associated with the listing of stock and stock index derivatives in Switzerland. Based on a univariate GARCH (1, 1) specification of the stock's index variance and a time-varying unitary risk premium representation, we cannot reject the hypothesis that stock and stock index derivatives listings affected the total risk premium Contrarily to previous empirical evidence, we find that derivatives listings influence both the conditional market returns' variance and the unitary risk premium through structural shocks. The gradual market completion hypothesis is further corroborated in that, cumulatively, the three stock and stock index options futures derivatives listings reduced the unitary risk premium while the marginal impact of each successive listing decayed.