Impact of Future Derivatives on Stock Market Volatility

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Impact of Future Derivatives on Stock Market Volatility

Derivatives has been the talk of the financial world after it was accussed as the primary reason for such a deep financial crisis that affecetd the global economy in 2007. Thus, the modelling of asset returns and judging the volatility of stock market and whether the derivatives have a substantial effect on stock market volatility, is still the key task for every finance professional as it provides much needed on risk patterns involved in investment process. The Finance Gurus propose that stock market normally exhibit high levels of price volatility and cause concerns to the investor regarding unpredicatble outcomes, however with launch of derivatives in the nineties in the major
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However, with the introduction of derivatives in the financial world, more and more uninformed or irrational investors get atttracted to stock market and with lower information received by the traders in the cash markets, stock market experience a higher volatility of the price fluctuation.(Alexander, 2001)
In order to study the impact of future derivatives we will be using the S&P CNX Nifty Index as a benchmark index and to account for non-constant error variance in the return series a GARCH Model will be used by incorporating futures and options dummy variables in the conditional variance equation.
However, before proceeding with our analysis we must look at what existing literature concludes about impact of future derivatives on stock market volatility:

A number of studies have been conducted so far and each study had come up with its own conclusion. While one set of analysis indicates that inclusion of derivatives does not lead to destabilization of underlying market rather it improves liquidity in the stock market. On the other hand, second set of analysts reveals that their study provide evidence that derivatives do increase the stock market volatility. Thus, the topic is still debatable in finance world but before proceeding with our analysis we must look what the recent literature concludes about imapct of derivatives on stock market volatility:

1) Rahman(2001) in order to estimate the
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