Impact of Index Futures in Stock Market Volatility
Impact of Index futures derivatives on the stock market volatility (1998-2005)
Abstract
Derivative products like futures and options in Indian stock market have become important instruments of price discovery, portfolio diversification and risk hedging in recent times. This research study is an effort to study the impact of introduction of index futures on the stock market volatility. In order to capture the impact of introduction of index on the volatility of the underlying, a dummy variable which takes up the value zero in the pre-introduction of index futures and one in the post-introduction is included while specifying the volatility dynamics. The results indicate that there is an indication of short-term volatility reduction but in the long run there is no significant impact on the volatility of the stock market.
Keywords: Derivatives, dummy variable, index futures, stock market, volatility
Introduction
A derivative is a financial instrument whose value is derived from another underlying asset. The underlying asset can be foreign exchange, commodity price, interest rate, index of prices, equity or any other asset. The price of the derivative is driven by the spot price of the asset, which is the underlying. The derivative future contracts are exchange traded instruments where one party agrees to purchase an asset at future time for certain price and other party agrees to sell the asset at same time for same price.
In India index futures were introduced in June 2000 and one year down the line in June 2001 index options were also introduced.
Volatility of financial returns is best understood as the variability of the asset price and is estimated by the variance of the time series of prices. Volatility in any financial market is induced by changes in investor’s perceptions due to flow of new information to the relevant market at different points of time.
Over a period of time, derivative products like futures and options have become important
Abstract
Derivative products like futures and options in Indian stock market have become important instruments of price discovery, portfolio diversification and risk hedging in recent times. This research study is an effort to study the impact of introduction of index futures on the stock market volatility. In order to capture the impact of introduction of index on the volatility of the underlying, a dummy variable which takes up the value zero in the pre-introduction of index futures and one in the post-introduction is included while specifying the volatility dynamics. The results indicate that there is an indication of short-term volatility reduction but in the long run there is no significant impact on the volatility of the stock market.
Keywords: Derivatives, dummy variable, index futures, stock market, volatility
Introduction
A derivative is a financial instrument whose value is derived from another underlying asset. The underlying asset can be foreign exchange, commodity price, interest rate, index of prices, equity or any other asset. The price of the derivative is driven by the spot price of the asset, which is the underlying. The derivative future contracts are exchange traded instruments where one party agrees to purchase an asset at future time for certain price and other party agrees to sell the asset at same time for same price.
In India index futures were introduced in June 2000 and one year down the line in June 2001 index options were also introduced.
Volatility of financial returns is best understood as the variability of the asset price and is estimated by the variance of the time series of prices. Volatility in any financial market is induced by changes in investor’s perceptions due to flow of new information to the relevant market at different points of time.
Over a period of time, derivative products like futures and options have become important