An Empirical Study on Impact of Index Futures Trading On Spot Market in India

SATHYA SWAROOP DEBASISH

Abstract


In this paper, an attempt is made to investigate the effect of futures trading on the volatility and operating efficiency of the underlying Indian stock market by taking a sample of selected individual stocks. Specifically, the study  examines whether the index futures trading in India  has caused a significant change in spot price volatility of the underlying  stocks  and how the index futures trading has affected market/trading efficiency in the Indian futures and stock markets. The effect of the introduction of futures trading is examined using an extended period of June 1995 to May 2009.We employ an event study approach to test whether the introduction of index futures trading has resulted in significant change in volatility and efficiency of the stock returns. The study compares spot price volatility changes before and after futures trading is introduced in the stock indices. The result shows that the introduction of Nifty index futures trading in India is associated with both reduction in spot price volatility and reduced trading efficiency in the underlying stock market. The results of this study suggest that there is a trade-off between gains and costs associated with the introduction of derivatives trading at least on a short-term perspective. This paper offers a unique contribution in examining the impact of introduction of index futures trading in NSE Nifty index and the index futures covering a period since introduction of index futures in Indian Capital Market.  The results suggest that the market would have to pay a certain price, such as a loss of market efficiency for the sake of market stabilization. Hence, a desirable market policy for derivatives trading would be one that would preserve market stabilization while still not damaging market efficiency in the underlying spot market.

Key Words: Futures, Financial Engineering, NSE Nifty, Event study, Market Efficiency.

JEL: G13, G15.



Keywords


Futures, Financial Engineering, NSE Nifty, Event study, Market Efficiency

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