Accelerators of Depth in Nascent Derivative Markets

Case of Nairobi Securities Exchange (NSE)

Abstract

The Kenyan derivatives market is at nascency which raises doubt on its depth in the short term and hence the urgency for intervention. This paper examines the factors that would accelerate the market depth 154 days after its inauguration. We quantify the effect of hypothesized accelerators of derivatives market depth using granger causality and Autoregressive Distributed Lags model for the first 30 weeks of trading. We examine the effect of size of the underlying cash market, volatility and liquidity of the underlying spot market on the market depth of single stock futures and equity index futures. We employ Granger Cointegration Test, Johansen Cointegration Test and Autoregressive Distributed Lag Model (ARDL) and Error Correction Model as statistical inferences methods. We then conduct a communicative validity of the results with 32 key informants who directly interact with the derivative market and use their qualitative responses to enrich our findings and recommendations. Empirical results show that the size of the underlying cash market, volatility and liquidity of the underlying spot market does not accelerate the derivatives market depth. We find that the answers to acceleration lie in introduction of derivative products whose underlying assets are widely traded such as currency and agricultural commodities in addition to undertaking more market literacy and awareness efforts.