Impact of Individual Stock Derivatives Introduction in India on Its Underlying Spot Market Volatility

Abstract

This study has made an attempt to examine the impact of the introduction of derivative trading in individual stocks of different market capitalisations that are listed in NSE representing different industrial sectors of the Indian economy using the generalised autoregressive conditional heteroscedastic (GARCH)( p, q) model. This article contributes to existing literature first, by examining the effect of derivative introduction on return volatility of stocks of different market capitalisations. Second, while in earlier studies effect of derivative introduction on return volatility has been examined only on derivative related stocks, in this article it is examined both on derivative-related and derivative-unrelated stocks. Third, the article also examines the impact of derivative trading on stocks of different industrial sectors of the Indian economy. From the result of the study, we find that volatilities of stock returns have declined due to the introduction of derivatives trading on most of the individual large-cap stocks considered in the study, which are all derivative-related stocks. Though we find decrease in return volatilities of all the derivative-unrelated mid-cap stocks in our study, the results of the derivative-related mid-cap stocks are found to be mixed. In case of small-cap stocks, the results indicate a decrease in return volatilities of most of the derivative-related and derivative-unrelated stocks considered in the study. Moreover, there is evidence of volatility reduction for almost all the derivative-unrelated stocks. We find no significant sectoral differences while examining the impact of derivatives trading on return volatilities of stocks representing different sectors of the Indian economy.