Stock Market Volatility After The Introduction Of Derivatives

Stock Market Volatility After the Introduction Of Derivatives

Abstract

The purpose of this study is to investigate the effect of financial derivatives trading on the volatility of the Indian stock market. The NSE S& P CNX Nifty index has been utilized as a proxy for the stock market, and the time period considered by the research ranges from 1995-96 to 2008-09. The discovery implies that derivative trading has decreased volatility. The reduction in volatility is mostly due to the fact that derivative markets draw an extra set of traders to the market, resulting in an increase in trading volume. With a rise in trading volume, more liquidity will be reflected in the underlying market's pricing, causing the market to become more stable.

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Introduction

When there is a strong increase and severe fall in the markets in a short period of time, the stock market is called volatile. Volatility in the stock market has been a source of worry for policymakers and investors not just in India, but across the globe. An investor wants to know how much volatility or risk he or she is exposed to, since the more volatile a stock is, the riskier it is. Derivatives are the most sought-after products in contemporary securities trading that enable market participants to control risk. The basic rationale behind derivatives trading is that derivatives decrease risk by offering an alternative channel for investors to invest with reduced trading costs, and it allows investors to prolong their settlement via future contracts. 

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It increases liquidity in the stock market. They are contracts whose payment at expiry is decided by the underlying asset's price. Futures, forwards, options, and swaps are examples of derivatives that may be coupled with one other or with conventional securities and loans to form hybrid instruments. In recent years, derivative products such as futures and options on Indian stock exchanges have become significant tools for price discovery, portfolio diversification, and risk hedging.


Conclusion

Using the GARCH (1, 1) model, we investigated the volatility of the stock market following the introduction of futures. We looked at the S&P CNX Nifty and ten specific stocks, five of which are derivative stocks and the other five are not. In the case of index futures, volatility in the S&P CNX Nifty has decreased since the launch of S&P CNX Nifty futures, yet the size of the dummy variable is extremely low, indicating that volatility has decreased. In the case of seven particular stocks, volatility has increased, while three stocks have decreased in volatility. As a consequence, there are conflicting findings about the effect of futures on underlying spot market volatility.

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