The Linkages, Persistence, Asymmetry in the Volatility and the Effect of the Us Subprime Mortgage Financial Crisis, on the Spot and the Futures Rate's Returns in the Indian Stock Market

Abstract

This paper examines the effects of persistence, asymmetry, and the US Sub-prime Mortgage crisis on the volatility of the returns and also the linkages and causality between the spot and futures volatility by using various classes of the ARCH and GARCH models, and through the Granger’s causality. We have used two indices: one for spot and the other for futures, for the daily data from, June 12th 2000 to September 30th 2013 from Nifty stock market of India. The descriptive statistics of the ‘return data’ calculated from log first differences, shows that the returns are not following the normal distributions. The magnitude of the volatility in returns of the spot and the futures market are similar, and therefore there is no evidence that the futures market volatility is higher. We have then tested for ARCH effects, and subsequently employed various models of the ARCH and GARCH conditional volatility. The ARCH effect is significant in both spot and futures market returns volatility. The GARCH (1,1) model is found to be significant, and therefore, in contrast to an ARCH model, GARCH (1,1) model implies that the returns are not autocorrelated, have ‘short memory,’ and depend on the constant mean only, similar in a way, to the CAPM’S expected return concept. It supports the hypothesis of the efficiency of the markets. The negative ‘news’ has more significant effect on volatility, corroborating the ‘leverage impact’ in finance on market volatility. We have also tested the volatility spillover effects from spot return variance to future return variance, through adding explanatory variables to the variance equations. We have also, after knowing the stationarity properties of the ‘return series’ employed the Granger causality to know the linkages between spot and futures return volatility. Both methods support the spillover effects. There is bidirectional Granger’s causality between futures and spot return volatility. We also have used the dummy variable for the US Sub-prime mortgage financial crisis to know the effect on the volatility of the stock returns in Indian market and found that they are statistically significant. Indian stock market is thus integrated to the world stock markets and the news effects from outside, especially that of the US.