An Analysis of Volatility in the Derivative Spot Market

Abstract

Purpose: The derivative market has given a new dimension to the investors as well as the stock market structure. In India, there are a lot of investors who are not able to take high risks, so the development of derivatives has encouraged investors to trade in the stock market safely which may also affect the stock market volatility. In the current study, we have evaluated the influence of derivatives on spot market volatility in the last twelve years (2009 to 2022).

Design/Methodology/Approach: - For the analysis, time series data has been gathered for a period of twelve years from January 2009 to December 2022. Data has been collected from various indices such as the Nifty Junior Index, Nifty Index, Index futures, and S&P 500 Index. By taking the first log difference the closing price values have been converted into daily compound returns. Augmented Dicky Fuller test has been applied to convert time series data into stationary series.   The Lagrange Multiplier test is performed to determine whether the data could be utilized in a GARCH (Generalized Autoregressive Conditional Heteroscedasticity) iterative procedure. The GARCH (1,1) model has been employed for the analysis.

Findings: Results of the GARCH (1,1) model indicate that whole spot market volatility has been reduced after introducing the derivatives. According to the findings, Nifty Junior Returns have an inverse relationship with Nifty returns. Similar results can be seen for S&P 500 returns and Nifty Junior which have an inverse relationship. The volatility has been reduced after introducing options and futures in the market. But it is also found that following the GARCH model utilized, options have a greater impact on Nifty returns because their coefficients are greater than the futures.

Research Implications/ Future Scope: - The findings of this study are important for stock exchange executives, retail and institutional investors, as well as regulators. The results suggest that futures and options trading assist in their prescribed role of improving the quality of information and pricing efficiency to the spot market. This will empower the investors to prudently structure their strategies in both options and futures markets. This study can be extended to commodity and currency derivatives too.

Originality of the Research: - This research is an original study towards investigating the impact of derivative trading on spot market volatility in an emergent market such as India.