Effect of Equity Derivatives Trading on Spot Market Volatility in India: An Empirical Exploration

Abstract

The present paper examines the impact of equity derivatives trading on spot market volatility, particularly the effect of equity derivatives introduction on spot market volatility in Indian stock market by using daily returns of seventy three companies from April 01, 1998 to March 31, 2008 excluding holidays when there were no transactions. The GARCH (1, 1) model that captures the heteroscedasticity in returns has been applied to study market volatility. However, all the companies under study showed asymmetric response and, accordingly the GJR GARCH model that captures the asymmetric response has been applied by using CNX Nifty index return as the independent variable in order to remove the influence of market-wide factors on equity returns. The results indicate that the coefficient of the dummy variable is significant and negative. Thus, it can be said that introduction of equity derivatives trading has reduced spot market volatility.

Keywords: Equity Futures, Market Volatility, Asymmetric Response, GARCH