Impact of Derivative Market on Stock Market Volatility
ASIAN ACADEMY of MANAGEMENT JOURNAL of ACCOUNTING and FINANCE
AAMJAF, Vol. 4, No. 2, 43–65, 2008
THE IMPACT OF DERIVATIVES ON STOCK MARKET VOLATILITY: A STUDY OF THE NIFTY INDEX
T. Mallikarjunappa1* and Afsal E. M.2
Department of Business Administration, Mangalore University, Mangalagangotri – 574199, Mangalore, DK, Karnataka, India 2 School of Management and Business Studies, Mahatma Gandhi University, P.D. Hills, Kottayam – 686560, Kerala State, India *Corresponding author: tmmallik@yahoo.com
1
ABSTRACT
This paper studies the volatility implications of the introduction of derivatives on stock market volatility in India using the S&P CNX Nifty Index as a benchmark. To account for non-constant error variance in the return series, a GARCH model is fitted by incorporating futures and options dummy variables in the conditional variance equation. We find clustering and persistence of volatility before and after derivatives, while listing seems to have no stabilisation or destabilisation effects on market volatility. The postderivatives period shows that the sensitivity of the index returns to market returns and any day-of-the-week effects have disappeared. That is, the nature of the volatility patterns has altered during the post-derivatives period. Keywords: conditional volatility, heteroscedasticity, volatility clustering, market efficiency
INTRODUCTION The modelling of asset returns volatility continues to be one of the key areas of financial research as it provides substantial information on the risk patterns involved in investment and transaction processes. A number of works have been undertaken in this area. Given the fact that stock markets normally exhibit high levels of price volatility, which lead to unpredictable outcomes, it is important to examine the dynamics of volatility. With the introduction of derivatives in the equity markets in the late nineties in the major world markets, the volatility behaviour of the stock market has become
AAMJAF, Vol. 4, No. 2, 43–65, 2008
THE IMPACT OF DERIVATIVES ON STOCK MARKET VOLATILITY: A STUDY OF THE NIFTY INDEX
T. Mallikarjunappa1* and Afsal E. M.2
Department of Business Administration, Mangalore University, Mangalagangotri – 574199, Mangalore, DK, Karnataka, India 2 School of Management and Business Studies, Mahatma Gandhi University, P.D. Hills, Kottayam – 686560, Kerala State, India *Corresponding author: tmmallik@yahoo.com
1
ABSTRACT
This paper studies the volatility implications of the introduction of derivatives on stock market volatility in India using the S&P CNX Nifty Index as a benchmark. To account for non-constant error variance in the return series, a GARCH model is fitted by incorporating futures and options dummy variables in the conditional variance equation. We find clustering and persistence of volatility before and after derivatives, while listing seems to have no stabilisation or destabilisation effects on market volatility. The postderivatives period shows that the sensitivity of the index returns to market returns and any day-of-the-week effects have disappeared. That is, the nature of the volatility patterns has altered during the post-derivatives period. Keywords: conditional volatility, heteroscedasticity, volatility clustering, market efficiency
INTRODUCTION The modelling of asset returns volatility continues to be one of the key areas of financial research as it provides substantial information on the risk patterns involved in investment and transaction processes. A number of works have been undertaken in this area. Given the fact that stock markets normally exhibit high levels of price volatility, which lead to unpredictable outcomes, it is important to examine the dynamics of volatility. With the introduction of derivatives in the equity markets in the late nineties in the major world markets, the volatility behaviour of the stock market has become
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