Derivative Trading and Volatility of the Underlying: Evidence from Indian Stock Market

Abstract

 In the present study, the impact of derivatives trading on the under lying spot market volatility has been analysed using symmetric and asymmetric GARCH methods. To separate the effect of market pervasive factors influencing volatility, return on NSE nifty is included in the mean equation. Further, in order to capture the impact that introduction of derivatives has had on the volatility of the underlying, a dummy variable which takes up value zero (0) pre introduction of derivatives and one (1) post introduction is included while specifying the volatility dynamics. The results indicate the existence of asymmetric response to new information. Sufficient evidence has been found of a reduction of volatility after the introduction of derivatives trading.