Impact of Introducing Derivatives Trading on Volatilities of Sectoral Stock Indices in India

Abstract

The paper analyses different properties of sectoral stock index volatilities in India using daily closing price data of five sectoral indices in NSE, namely, CNX Bank, CNX Finance, CNXIT, CNXFMCG and CNX Pharma Index and the impact of derivatives' introduction on their return volatilities in an EGARCH (1, 1) framework. India amended its patent law on March 22, 2005, thereby abolishing its "process"patents law introduced "product"patents for pharmaceuticals, food and chemicals. Hence in the paper the volatility of stock index return in Indian pharmaceuticals industry has been specially examined to see whether there is any change in it in the post product patent period. The results of the study show that introduction of derivative trading has mixed impact on sectoral stock index volatilities. We also observe significant increase in return volatility of CNX Pharma index after the introduction of product patent system in the pharmaceutical sector due to amendment of patent law in 2005 supporting the hypothesis of positive relation between higher uncertainty regarding industry's average future profits related to increased R&D intensity in the post product patent period and increased return volatility.