Impact of Derivatives and Asymmetric Effect on Indian Stock Market Volatility

Abstract

The paper investigates the impact of underlying spot market volatility after the introduction of futures and options trading in India by using standard EGARCH (1,1) model. The dataset was retrieved from National Stock Exchange (NSE) website for daily closing price series of S&P CNX Nifty spot index for the period from 1 st January 1996 to 31 st March 2009. The findings suggest that, both futures and options trading reduce the volatility of spot market after the introduction of futures and options trading in India. Besides, the results of futures and options markets reveal that there were no asymmetric effects present in Indian spot market. This finding are quite interesting, since noise trading is the cause of asymmetric responses, the Nifty spot index was not significantly affected by such market participants. Hence, the present study suggests that the introduction of futures and options trading have improved the speed and quality of information flowing in spot market. This enhances the overall market depth, increases market liquidity and ultimately reduces informational asymmetries and therefore compresses spot market volatility in India.