An Empirical Study of Efficiency Volatility Spillover and Violations in Spot Futures and Options Market of India

Abstract

In this research work analysis has been undertaken to study the efficiency, volatility spillover and violations in the spot and derivatives market. Market efficiency concept has been tested in weak form and semi-strong form in the major markets. A study on the co-integration and lead-lag relationship will provide an insight to the regulators. Volatility spillover refers to the transmission of volatility from one market to another. Research has shown that the retail participation in the equity market tends to shrink at the time of high volatility. Violations or mispricing is also a parameter of market efficiency and refers to the mispricing of an asset between two markets. The violation is a form of deviation from the conceptual relationship of a derivative contract with its underlying asset in the spot market. Weak form of efficient market hypothesis for the spot market has been tested using the Augmented Dickey Fuller test, Variance ratio test, Auto-correlation test and Runs test. All the concepts are tested taking the nifty spot index, nifty futures index and nifty options index data. The analysis is done for the overall market and not on the individual stocks. The rationale for selecting the index series was that this study is undertaken on many financial concepts and to cover market efficiency, co-integration, lead-lag relationship, volatility spillover, impact of derivatives and violations in one study is an extensive work. Overall analysis shows that the Indian capital market has developed with time in terms of market efficiency. The market in derivative segment is yet to achieve the stage, where it can be used to perfectly price the underlying asset as the options and futures contracts are frequently mispriced. newline newline