Existence and extent of impact of individual stock derivatives on spot market volatility in India

Abstract

This article first examines the existence of a change in the structure of conditional volatility of stock returns around the time when trading in individual stock derivatives is introduced. Thereafter,it analyses the extent of the structural change between the pre- and post- derivatives regimes, after allowing for asymmetric response to ‘good’ and ‘bad’ news, following the Generalized Autoregressive Conditional Heteroscedastic (GARCH) family of models. Since the exact point of regime change is known for each stock analysed, the article specifiesalternative switching asymmetric GARCH (Exponential GARCH (EGARCH), Periodic GARCH (PGARCH) and Glosten–Jagannathan– Runkle GARCH (GJRGARCH)) models for each stock. The final choice of model is made on the basis of the news impact curve. The main finding of this study is thatal though derivatives seem to enhance the quantity of information transmitted to the spot market, the quality of such information is doubtful, resulting in delayed incorpora...