Academic journal article IUP Journal of Applied Finance

Behavior of Volatility in the Indian Stock Market with Respect to Some Ecopolitical Factors

Academic journal article IUP Journal of Applied Finance

Behavior of Volatility in the Indian Stock Market with Respect to Some Ecopolitical Factors

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Perhaps, the most successful and innovative financial instrument in the financial world has been the derivatives contracts. Having been introduced in Chicago, USA in the year 1982, it has spread all over the world like a blaze. Soon after its introduction in the 1980s, derivatives contracts took the major financial centers world over by storm, e.g., Australian stock market started trading futures contract in 1983, London started in the year 1984, the Hong Kong stock market started in 1986 and many more. Although it was not as early as the developed nations did, India finally launched the futures contracts in June 2000. Post-liberalization, in the early 1990s, Indian stock market and the economy as a whole showed immense potential as becoming a financial powerhouse. Considering the exponential growth of the Indian stock markets, Indian stock market watchdog Securities and Exchange Board of India (SEBI) decided to introduce the futures contracts in the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). Integrating the Indian financial markets with the other developed financial markets and improvising market efficiency were the major objectives behind the introduction of derivatives in the Indian financial market. This was possible due to the recommendation provided by the L C Gupta Committee. The investors in capital markets have the independence of bearing a certain amount of risk beyond which the risk can be hedged away only in case of derivatives, and so it was absolutely imperative to introduce futures and options contracts in the Indian financial markets. The efficiency of a stock market is complemented by the efficiency of the derivatives market of the same country. Manipulators, arbitrageurs and hedgers are the main information seekers and these information seekers actually benefitted from the introduction of the derivatives market and they also helped to improve the efficiency of the derivatives market and the stock markets simultaneously. Many researchers have found that there is a significant effect of listing derivatives on the cash markets of the countries like Japan, USA and UK (Gulen and Mayhew, 2000). On the other hand, some researchers have also found that introduction of derivatives has no impact on the volatility of the stock market. However, some researchers have concluded that the major contributions of derivatives are hedging and price discovery, which result in influencing the stock market (Rahman, 2001). Although the introduction of derivatives may have significant impact on the volatility of the stock market, there are other potential factors as well which can equally impact the volatility of the stock market. The primary objective of this paper is to analyze the effect of some of the economic and political variables on the volatility of the Indian stock market. The proxy variable for the stock market has been taken to be the NSE S&P CNX Nifty. Three dummy variables have been constructed: introduction of derivatives, announcement of union budget every year and the occurrence of Lok Sabha elections. It has been assumed that the financial investors are a bit skeptical about investing in stocks during the period commencing from one month prior and one month after the union budget has been announced. Hence, there is a chance that during this period every year, there is a change in the volatility of stock markets and so the dummy variable for budget has been made accordingly. Similarly, for the Lok Sabha elections also, the dummy variable has been constructed accordingly. The objective of this study is to understand the interrelation between the stock market growth and the derivatives market. This study also intends to find out the behavior of the Indian stock market on the basis of the economic scenario of the country.

Moreover, it is observed that the time periods for these dummy variables are overlapping and so it is interesting to examine the pairwise interaction effect of these dummy variables on the movement of the Indian stock market. …

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