Impact of Derivative Trading on Stock Market Volatility in India: A Study of few Selected Stocks of Nifty Index

Abstract

This research study analyses the impact of derivative trading on Indian stock market volatility. The sample data consist of closing prices of S&P CNX Nifty and ten stocks whose trading data is available for the period from January 1996 to December 2005.The study uses GARCH (1, 1) model to examine the nature of volatility over time of S&P CNX Nifty and stocks under study.Augmented Dickey Fuller (ADF) test is conducted to ascertain whether the return series is stationary or not. In this study, we have tried to address two objectives. First, how the initial introduction of derivative contracts impact cash market volatility, second, whether the existence of futures trading affects daily volatility in the cash market or not. To address the first objective, we introduce a dummy variable into the conditional variance equation and to address the second objective, we divide the sample into the pre-futures and post-futures sub-sample and a GARCH model is estimated separately for each sub-sample. This allows us to compare the nature of volatility before and after the onset of futures trading. The evidences suggest that there is no significant change in the volatility of S&P CNX Nifty, but the structure of volatility has changed to some extent. However, results show mixed effect in case of 10 individual stocks. The results are in consonance with other previous studies which help investors and regulators to take informed decisions regarding investment in stock market.