The Impact of Derivatives on Stock Market Volatility: A Study of the Sensex Index

Abstract

One of the most important issues that have engaged the financial managers and the academicians in Finance all over the world is the financial markets volatility and the need to forecast it accurately. The stock prices depend on the investment behavior which, in turn, is affected by the efficiency of volatility forecasting. The purpose of this paper is to examine the volatility in the Indian stock market after the introduction of futures contracts on the SENSEX index. To explore the time series properties Unit Root Test and ARCH LM test have been employed. GARCH (1, 1) model have been applied to study the impact on underlying volatility, for this sample period of 26 years has been taken. The results of this study indicate that the introduction of futures leads to a significant change in the spot market volatility of the SENSEX index and it is successful in reducing the volatility.

Keywords: Conditional volatility, Futures, GARCH, Market efficiency, Volatility, Volatility clustering

JEL Classification: C01, C32, C87, G11