An Empirical Analysis of Currency Futures Market in India

Abstract

The currency derivative market is vital for facilitating seamless international trade and investment by managing foreign exchange risks. Traders and investors need to understand how exchange rates are determined to anticipate currency movements and make informed decisions. Accurate hedging protects businesses from adverse currency fluctuations, ensuring stability in cross-border transactions. However, volatility spillover effects can transmit risks across borders, leading to economic contagion. Unfortunately, a lack of awareness about this market poses challenges for participants in effectively managing their risks. The current study focuses on the understanding of the interconnectedness between spot and futures prices during crisis period. Our study used real-time spot and futures prices of USD/INR traded on the National Stock Exchange (NSE), India. The time-series data is classified into two-time frames, i.e., the preCOVID-19 Phase (from 1st August 2019 to 24th January 2020) and the COVID19 Phase (from 25th January 2020 to 31st August 2020). By applying the Autoregressive Distributed Lag (ARDL) approach and MGARCH Diagonal VECH model the study found a bidirectional association between the two markets for both sample periods after controlling macroeconomic news releases and volume-based market sentiments. However, the study also found that the futures market has emerged as the leading market in the long run, and the spot market leads to the futures market in the short run. Further, the MGARCH Diagonal VECH model shows that the volatility impact from currency spot to futures market is more substantial during the pre-and outbreak of the COVID-19 pandemic period. The study has also found that OLS model provides better hedge ratio and hedging effectiveness as compared to VECM and BEKK-MGARCH model during the pandemic. The findings of the study are useful for the policy makers and the market participants to control the volatility. It is also useful for the hedgers to understand the best method of hedging so that...