Academic journal article South Asian Journal of Management

Economic Growth and Volatility in Indian Stock Market: A Critical Analysis

Academic journal article South Asian Journal of Management

Economic Growth and Volatility in Indian Stock Market: A Critical Analysis

Article excerpt

Stock market volatility is an important concept for understanding the investors' responsiveness, and thereby it facilitates to work on investment strategy. This paper examines the volatility in Indian stock market of daily and monthly return for the period from January 1996 to December 2005 with three different point of views - volatility of daily return in a year, volatility of daily return in a month, and volatility of monthly return in a year with respect to economic growth. For the analysis, adjusted opening and closing price of the Bombay Stock Exchange listed index BSE 100 have been examined. The study period exhibits a mixed set of economic environment, wherein Indian economy has observed three distinct economic phases successively - decline, recession and growth. The study involves interpretations and testing of volatility in purview of different economic environment, which has wide ranging implications for policymakers and investors. It also attempts to recognize the factors responsible for generating volatility. The study also examines volatility trend of both daily and monthly returns in futuristic scenario. The Indian stock market has witnessed relatively less volatility during the growth period (2003-2005), as compared to decline (1996-1999) and recession (2000-2002) periods. Volatility is the highest during the decline period. It documents that investors are largely responsive to economic fundamentals.

INTRODUCTION

Volatility in the stock market is a matter of great concern for policy makers and investors. Large fluctuations in the stock prices, which exhibit volatility, bring variation in the value of the investors' portfolio. Stock market does not perform consistently in all economic situations. Consequently, portfolio value of investors also undergoes changes depending upon the economic conditions. Investors' expectations with respect to tangible and intangible economic fundamentals tend them to inflow/outflow of their funds from stock market' which results volatilitY- A number of empirical studies examine stock market volatilitY resultant to change in ec°nomic and financial variables, and Point out that investors are largely sensitive to these variables. (Binder and Merges- 2001; Flannery and Protopapadakis, 1002' and Mala and Reddy- 2007)' As a «suit, short and long trends in stock market return and volatility with respect to market fundamentals can be observed over a period of time. Day-to-day business operations, political, and social events cause the short-term trend of volatility. The high volatility is resultant to sudden change in standard deviation. Studies of Aggarwal et al. (1999), and Bailey and Chung (1995) report that the period of sudden high volatility tend to be associated with country specific factors like corporate earning, political, and government decisions having significantly bearings. The long trend of volatility, necessarily, should be associated with economic growth (Officer, 1973; and Schwert, 1989). Investors tend to change the risk premium return of their portfolios with regard to changing macroeconomic fundamentals like inflation, interest rate, exchange rate, and industrial production, which evolve the long-term trend of volatility.

Large variability in market fundamentals, which results long-term volatility in stock market poses risk to those investors who keep their fund invested in the marketable securities like common stocks for long period. There are two propositions, which affect the fancy of an investor, e.g., risk and return. Return includes both cash dividend and net increase or decrease in value of the investment. Risk exhibits variability in the mean rate of return in response to corporate, economic or some general events or forces. Volatility in the stock market is the index of risk. It can be measured on a month-to-month, year-to-year, day-to-day or even hour-to-hour basis. Volatility, in fact, reflects the arrival of new information, which is absorbed by the investors, and thereby brings changes in their exposure to stock market accordingly. …

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