Derivatives Trading and Volatility - A Study of the Indian Stock Markets

Abstract

Equity derivatives trading started on June 9, 2000 with introduction of stock index futures by Bombay Stock Exchange (BSE). National Stock Exchange (NSE) also commenced its trading on 12 June, 2000 based on S&P Nifty. Subsequently, other products like stock futures on individual securities, index options and options on individual securities were introduced. This paper tries to examine the impact of derivatives trading on the volatility of S&P Nifty and BSE Sensex using ARCH/GARCH technique. It also examines the behaviour of volatility of other indices such as Nifty Junior, NSE 200, S&P Nifty 500, BSE-100 and BSE-200 to see whether the market wide volatility has declined over the sample period. Further, surrogate indices like BSE100 and Nifty Junior are used to assess whether the introduction of derivatives per se has been instrumental or the volatility has plummeted in line with general fall in market wide volatility. The results established that introduction of futures and options have negligible or no effect on the volatility as evident from GARCH (1, 1) model. When surrogate index taken into consideration S&P Nifty showed decline in volatility while BSE Sensex exhibited rise in volatility. EGARCH model indicates fall in volatility in case of all indices.