Derivatives and Volatility on Indian Stock Markets

Derivative products like futures and options on Indian stock markets have become important instruments of price discovery, portfolio diversification and risk hedging in recent times. This paper studies the impact of introduction of index futures on spot market volatility on both S&P CNX Nifty and BSE Sensex using ARCH/GARCH technique. The empirical analysis points towards a decline in spot market volatility after the introduction of index futures due to increased impact of recent news and reduced effect of uncertainty originating from the old news. However, further investigation also reveals that the market wide volatility has fallen during the period under consideration. Surrogate indices like BSE 200 and Nifty Junior are introduced to evaluate whether the introduction of index futures per se has been instrumental in reducing the spot market volatility or the volatility has fallen in line with general fall in market wide volatility. The results using these surrogate indices show that while the ‘futures effect ’ plays a definite role in the reduction of volatility in the case of S&P CNX Nifty, in the case of BSE Sensex, where derivative turnover is considerably low, its role seems to be ambiguous