Characterization of Volatilities in the Nigerian Stock Exchange: Prospects for Options Trading

Abstract

This paper examined the characteristics of volatilities in the Nigerian stock exchange (NSE) and their prospects for option trading. Also, the paper tested the information efficiency of the historical volatilities of the NSE All Share Index (ASI) and NSE30 Index equities using Variance Ratio Wild Bootstrap Joint Tests. The study found that one equity has a long left tail distribution, while others were positively skewed. Three equities have kurtosis and Jarque Bera probability statistics that approximate that of a normal distribution. All other stocks including the NSE ASI are leptokurtic and have Jarque Bera statistics that indicate strong conditional heteroscedasticity. The standard deviation statistics show that the degree of volatility vary among the NSE30 index equities. The Variance Ratio Wild Bootstrap Joint Tests based on the Chow-Denning maximum |z| statistic show that for the monthly volatilities, eight equities and the NSE ASI generally reject the null hypothesis that they are martingales. The three month moving volatilities, shows that three stocks strongly reject the null of a martingale while the NSE ASI and the rest of the NSE30 Index equities failed to reject the null hypothesis. Given the standard deviation of the NSE30 Index equities monthly and three month moving volatilities, option traders may be better off writing/buying options on these equities than the NSE ASI which is comparably the least volatile. As for whether investors can rely on past volatility information on the NSE ASI and NSE30 Index equities, the results are mixed and therefore depends on the particular asset of interest.

Keywords: Nigerian Stock Exchange, Characterization of Volatility, Options, Variance Ratio Test, Wild Bootstrap, Martingale