Derivative trading and structural breaks in volatility in India: an ICSS approach

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Researchers argue that ignoring the structural breaks in the time-series variance can cause significant upward biases in the degree of persistence in estimated GARCH models. Against this backdrop, the present study empirically examines the effect of stock futures on the underlying stock’s volatility in India by incorporating the structural breaks with the help of ICSS test and AR (1)-GARCH (1, 1) model for 30 most liquid and actively traded underlying stocks and their associated futures contracts. The study period ranges from the 1st January 2000 or the listing date of the particular stock (whichever is prior) till 31st March 2019. The study contributes to the on-going debate regarding the effect of derivatives on the underlying stock market’s volatility in two ways. Firstly, by taking into consideration the breaks in the volatility and, secondly, studying the effect of single stock futures will allow us to evaluate company-specific response to futures trading directly. The study offers a mixed outcome for the stocks under consideration. However, there is evidence of a decline in unconditional volatility for the majority of the stocks. The overall findings indicate that trading in stock futures may not have any detrimental effect on the underlying stock’s volatility.

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    • Figure 1. Multiple Structural Breaks (Iterated Cumulative Sums of Squares (ICSS) algorithm of Inclan and Tiao (1994)
    • Table 1. List of selected stocks and their volume
    • Table 2. Unit root test (augmented Dickey-Fuller test)
    • Table 3. Results of ARCH test
    • Table 4. Impact of stock futures on the volatility of underlying stocks
    • Investigation
      Guntur Anjana Raju, Sanjeeta Shirodkar
    • Methodology
      Guntur Anjana Raju, Sanjeeta Shirodkar
    • Resources
      Guntur Anjana Raju
    • Software
      Guntur Anjana Raju, Sanjeeta Shirodkar
    • Supervision
      Guntur Anjana Raju
    • Validation
      Guntur Anjana Raju
    • Writing – review & editing
      Guntur Anjana Raju
    • Conceptualization
      Sanjeeta Shirodkar
    • Data curation
      Sanjeeta Shirodkar
    • Formal Analysis
      Sanjeeta Shirodkar
    • Project administration
      Sanjeeta Shirodkar
    • Visualization
      Sanjeeta Shirodkar
    • Writing – original draft
      Sanjeeta Shirodkar