Do Derivatives Matter?: Evidence from a Policy Experiment

57 Pages Posted: 2 Feb 2016

See all articles by Deepak Agrawal

Deepak Agrawal

Indian School of Business

K.R. Subramanyam

University of Southern California - Leventhal School of Accounting

Prasanna L. Tantri

Indian School of Business

Ramabhadran S. Thirumalai

Indian School of Business

Date Written: December 9, 2015

Abstract

We study the impact of derivatives on stock characteristics such as valuation, price efficiency, and liquidity. We resolve the endogeneity issue faced in the extant literature by using an order issued by the Indian market regulator that resulted in delisting of 51 stocks from the derivative segment. Using this policy experiment, we examine the conflicting hypothesis regarding the impact of derivatives on stock fundamentals. We find that excluded firms underperform the market by 4.07% during the event window. We identify decline in price efficiency and reduction in liquidity as channels through which the above phenomenon manifests. Contrary to the expectations of the regulators, volatility largely remains unchanged. We rule out regulatory targeting by employing several placebo and other robustness tests. We conclude that derivatives indeed add value by improving price efficiency and liquidity of a stock.

Keywords: Derivative, Short sell constraint, Market efficiency, Market integrity

JEL Classification: G12, G14

Suggested Citation

Agrawal, Deepak and Subramanyam, K.R. and Tantri, Prasanna L. and Thirumalai, Ramabhadran S., Do Derivatives Matter?: Evidence from a Policy Experiment (December 9, 2015). Asian Finance Association (AsianFA) 2016 Conference; Indian School of Business WP 2726446. Available at SSRN: https://ssrn.com/abstract=2726446 or http://dx.doi.org/10.2139/ssrn.2726446

Deepak Agrawal (Contact Author)

Indian School of Business ( email )

Hyderabad, Gachibowli 500 019
India

K.R. Subramanyam

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States
213-740-5017 (Phone)
213-747-2815 (Fax)

Prasanna L. Tantri

Indian School of Business ( email )

Hyderabad, Gachibowli 500 032
India
9160099959 (Phone)

Ramabhadran S. Thirumalai

Indian School of Business ( email )

Gachibowli
Hyderabad, Andhra Pradesh 500 032
India
+91 (40) 2318 7151 (Phone)
+91 (40) 2300 7017 (Fax)

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