Title: Impact of derivatives trading on spot market volatility: an empirical study

Authors: Naliniprava Tripathy, S.V. Ramana Rao, A. Kanagaraj

Addresses: Indian Institute of Management, Mayurbhanja Complex, Nongthymmai, Shillong-793014, Meghalaya, India. ' Indian Institute of Management, Mayurbhanja Complex, Nongthymmai, Shillong-793014, Meghalaya, India. ' Indian Institute of Management, Mayurbhanja Complex, Nongthymmai, Shillong-793014, Meghalaya, India

Abstract: This paper investigates the impact of introduction of derivative instruments and leverage and asymmetric effect on spot market volatility (Nifty) in India during the period October 1995 to December 2006 by using GARCH, EGARCH, TARCH and component ARCH model. The results suggest towards a decline in spot market volatility and market efficiency improved after introduction of index futures, stock futures, stock options and index options on the spot market due to increase impact of recent news. This study also finds evidence of leverage and asymmetric effect on spot market where the conditional variance is an asymmetric function of past innovation, rising proportionately more during market declines. It is also observed that the asymmetric GARCH models provide better fit than the symmetric GARCH model. Thus to predict stock market volatility, one should use the asymmetric model which can capture the so-called leverage effect observed in our study.

Keywords: generalised autoregressive conditional heteroscedasticity; exponential GARCH; EGARCH; threshold ARCH; TARCH; component ARCH model; index futures; index options; stock options; stock futures; dummy coefficients; derivatives trading; spot market volatility; spot markets.

DOI: 10.1504/IJADS.2009.026553

International Journal of Applied Decision Sciences, 2009 Vol.2 No.2, pp.209 - 232

Published online: 19 Jun 2009 *

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