A Major Project Report

Submitted in partial fulfillment of the requirements for BBA (General) programme of Guru Gobind Singh Indraprastha University, Delhi

Submitted by Rahul Arora BBA (Gen) Semester-VI Enrol. No.: 0651221708

Delhi College of Advanced Studies B-7, Shanker Garden, Vikaspuri New Delhi-110018


I hereby declare that the major project report, entitled ³Volatility in Stock Market´, is based on my original study and has not been submitted earlier for award of any degree or diploma to any institute or university.

The work of other author(s), wherever used, has been acknowledged at appropriate place(s).

Place: New Delhi Date:

Candidate¶s signature Name: Rahul Arora Enrol. No.: 0651221708


Name: Ms. Yamini Soi Supervisor Delhi College of Advanced Studies

Name: Dr. J.P. Varshney Director Delhi College of Advanced Studies



An independent project is a contradiction in terms. Every project involves contribution of many people. This project also bears the imprints of many people and it is a pleasure for me to acknowledge and thank all of them.

I am deeply indebted to Prof. Yamini Soi who acted as a mentor and guide, providing knowledge and giving me their valuable time out of their busy schedule, at every step throughout the research. It is only because of him this project came into being.

I also thank the Director of Delhi College of Advanced Studies, for providing an opportunity of doing this project under his leadership.

I also take the opportunity to express my sincere gratitude to each and every person, who directly or indirectly helped me throughout the project and without anyone of them the research, would not have been possible.

The immense learning from this project would be indelible forever.

Student Name Enrl.No.


higher volatility means a greater chance of a shortfall. through the use of derivative securities such as options and variance swaps. 4) Higher volatility of return when retired gives withdrawals a larger permanent impact on the portfolio's value. volatility most frequently refers to the standard deviation of the continuously compounded returns of a financial instrument within a specific time horizon. Volatility is normally expressed in annualized terms. and amongst the models are Bruno Dupire's Local Volatility. none of these are observed in real markets. even while it is the returns' volatility that is being measured. 2) When certain cash flows from selling a security are needed at a specific future date. 3) Higher volatility of returns while saving for retirement results in a wider distribution of possible final portfolio values. It is used to quantify the risk of the financial instrument over the specified time period. It is common for discussions to talk about the volatility of a security's price. 5) Price volatility presents opportunities to buy assets cheaply and sell when overpriced. and it may either be an absolute number ($5) or a fraction of the mean (5%). and the increasingly popular Heston model of Stochastic Volatility.EXECUTIVE SUMMARY In finance. Although the Black Scholes equation assumes predictable constant volatility. Investors care about volatility for five reasons. it is also possible to trade volatility directly. In today's markets. 1) The wider the swings in an investment's price the harder emotionally it is to not worry. 4 . Poisson Process where volatility jumps to new levels with a predictable frequency.

Thus chaos prevails in the markets with investor optimism at unexpected levels. In past few years stock market has become quite volatile. y Has the stock market volatility increased? y Has the Indian market developed into a speculative bubble due to the emergence of "New Economy" stocks? y Why is this volatility so pronounced? The objective of this paper is try to analyze these questions in the context of Indian stock markets. It has become quite difficult to predict the erratic movement shown which is in not at all in tandem with the information which is fed to stock market. Its an attempt to unearth the rationale for these weird movements 5 .OBJECTIVES The movement of stock market has always been a puzzle.

SCOPE The Indian Stock Market is well known for its volatility i. it is unpredictable and may work according to demand and supply conditions .e. One have to make a better portfolio and keep a record of it to judge That the chosen company may be able to give better return. The stock markets may be different for traders and investors but both have same motive that is to maximize the investment. In this we did a proper analysis of the several Stocks and try to see the trends that may able to prove that market give chances to make money at every levels . 6 . Foreign Institutional Investors Involvment . Mergers . It may involve Quantitative analysis of the Stocks which involve making tables and graphs to ascertain viability of the company. NSE. Stock Market involves the certain exchanges which help in dealing in stocks such as BSE . Take overs and acquisitions of the companies etc may give a a diverse directions to the Indian Stock Market.

making it crazy? We try to prove how these perceptual changes have changed volatility through empirical evidence. A Psychology view states that stock market is more of emotional driven. Close to close volatility 7 . The inter±day volatility is calculated byclose to close and open to open volatility method. The study tries to correlate the economic growth concept with the growth of stock market of India. Trying to examine this fact all the key macro and micro economic factor growth is being observed with respect to growth in stock market. Standard deviation is used to calculate inter± day volatility. The stock market regulation in introduction of rolling settlement and dematerialization as a measure of reducing volatility is put to test. A fundamentalist view says that the stock market react with information flowing in the stock market. On the other hand.Inter±day volatility is computed by close to close and open to open value of any index level on a daily basis. the view that volatility is caused by psychological factors is also tested.METHODOLOGY First of all we examine the fundamentalist view put forward by economists who argue that volatility can be explained by Efficient Market Hypothesis. It is the micro and macro economic factors that drives the market. Inter±day Volatility The variation in share price return between the two trading days is called inter±day volatility. What precipitating factors started this remarkable surge. It is the perception of the investors that greatly affects the stock market. After that an empirical study of BSE Sensex and a set of representative stocks are carried out to find the changes in their volatility in the last two years. So We try to study how the change in habits and perceptions affected the price movements.

It indicates how the indices and shares behave in a particular day. Intra±day Volatility The variation in share price return within the trading day is called intra±day volatility. Intra± day volatility is calculated with the help of Parkinson Model and Garman and Klass model. 8 . the closing values of the Nifty and Sensex are taken.For computing close to close volatility. Close to close volatility (standard estimation volatility) is measured with the following formula Open to open volatility Open to open volatility is considered necessary for many market participants because opening prices of shares and the index value reflect any positive or negative information that arrives after the close of the market and before the start of the next day¶s trading . Inter±day volatility takes into account only close to close and open to open index value and it is measured by standard deviation of returns.

A stock index represents the change in value of a set of stocks. indexes have come to the forefront owing to direct applications in finance in the form of index funds and index derivatives. 9 . which captures the behavior of the overall equity market. fund managers. which constitute the index . it should be well diversified and yet highly liquid. investment advisors. Hedging using index derivatives has become a central part of risk management in the modern economy. a stock index number is the current relative value of a weighted average of the prices of a pre-defined group of equities. which measures the change in a set of values over a period of time. In the recent past this glamorous stock market indicator dances aggressively. and last but not the least to the regulators? Do these numbers have any significance? Do they have any scientific basis? How does a layman understand these numbers? What exactly that goes into these numbers? In recent years.doing? What-the-Index-Means? An index is a number.Characteristics-of-a-goodIndexA good stock market index is one. It should represent the market. Index derivatives allow people to cheaply alter their risk exposure to an index (hedging) and to implement forecasts about index movements (speculation). The starting value or base of the index is usually set to a number such as 100 or 1000. Securities market indexes have been constructed to give a quick answer to the question: What is the-market. Does the movement of Nifty or Nifty really mean anything to the investors.More specifically. It is a relative value because it is expressed relative to the weighted average of prices at some arbitrarily chosen starting date or base period.INTRODUCTION. 'Nifty' the glamorous dancing beauty of traditional Indian stock market. Movements of the index should represent the returns obtained by "typical" portfolios in the country. This paper is aimed at throwing lights on various factors that made our nifty baby to dance fast with lots of forward steps.

which decides the policies and regulates the affairs of the Exchange.sebi. Unity (one third of them retire ever year by rotation). SEBI's website location is at http://www. Chennai. which was established in 1878. popularly known as" BSE" was established in 1875 as "The Native Share and Stock Brokers Association". It is the oldest one in Asia.gov. A Governing Board having 20 directors is the apex body. BSE (Bombay Stock Exchange) The Stock Exchange.in but you need a password to access it. There is also a National Stock Exchange (NSE) which is located in Mumbai. 1956. y y y Total number of stock exchanges in India: 22 They are in: Ahmedabad. More than 6. It is the first Stock Exchange in the Country to have obtained permanent recognition in 1956 from the Govt. three SEBI nominees. 10 . y The regulatory agency which oversees the functioning of stock markets is the Securities and Exchange Board of India (SEBI). even older than the Tokyo Stock Exchange. The Governing Board consists of 9 elected directors. of India under the Securities Contracts (Regulation) Act. Delhi etc. Established in 1875. Bangalore. six public representatives and an Executive Director & Chief Executive Officer and a Chief Operating Officer.000 stocks listed. y There is also an Over The Counter Exchange of India (OTCEI) which allows listing of small and medium sized companies. who are from the broking comm. which is also located in Bombay. Mumbai.y India's oldest and first stock exchange: Mumbai (Bombay) Stock Exchange. Calcutta.

1996 and since then. The BSE Index Cell carries out the day-to-day maintenance of all indices and conducts research on development of new indices NSE (National Stock Exchange) NSE was incorporated in 1992 and was given recognition as a stock exchange in April 1993. 2006. DOLLEX-30 and the country's first free-float based index . the Price to Book Value Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices. In 2001.the BSE TECk Index. with trading on the Wholesale 11 . BSE launched two new index series on 27 May 1994: The 'BSE-200' and the 'DOLLEX-200'. it is being calculated taking into consideration only the prices of stocks listed at BSE. Delhi. This Committee which comprises eminent independent finance professionals frames the broad policy guidelines for the development and maintenance of all BSE indices. BSE-500 Index and 5 sectoral indices were launched in 1999.BSE Indices The launch of SENSEX in 1986 was later followed up in January 1989 by introduction of BSE National Index (Base: 1983-84 = 100). BSE disseminates information on the Price-Earnings Ratio. BSE launched BSE-PSU Index. All BSE Indices are reviewed periodically by the BSE Index Committee. Ahmedabad and Madras.Mumbai. It started operations in June 1994. It comprised 100 stocks listed at five major stock exchanges in India . Over the years. BSE shifted all its indices to the free-float methodology (except BSE-PSU index). BSE website and news wire agencies. BSE launched the dollarlinked version of BSE-100 index on May 22. The BSE National Index was renamed BSE-100 Index from October 14. The values of all BSE indices are updated on real time basis during market hours and displayed through the BOLT system. Calcutta.

it is about how fast prices move. including:[13] y y y y y S&P CNX Nifty(Standard & Poor's CRISIL NSE Index) CNX Nifty Junior CNX 100 (= S&P CNX Nifty + CNX Nifty Junior) S&P CNX 500 (= CNX 100 + 400 major players across 72 industries) CNX Midcap (introduced on 18 July 2005 replacing CNX Midcap 200) CONCEPTUAL FRAMEWORK When we think about stock market.Debt Market Segment. Today's market deals directly with volatility through options and variance swaps. we think about its volatile nature. If the price almost never changes. There are many definations of volatility but in simple words volatility is "the rate and magnitude of changes in price". Unpredictability is the essential part of the market. Accounting the annualized standard deviation of daily change in price leads to evaluation of volatility. if the price of a stock moves up and down rapidly over short time periods. it has high volatility. 12 . it has low volatility. Volatility is low when the market is quite but moving in range of trade. NSE Indices NSE also set up as index services firm known as India Index Services & Products Limited (IISL) and has launched several stock indices. Volatility in stock market is the relative rate at which the price of a security moves up and down. In simple terms. Subsequently it launched the Capital Market Segment in November 1994 as a trading platform for equities and the Futures and Options Segment in June 2000 for various derivative instruments.

Volatility can also cause investors to respond irrationally. A beta greater than 1 means the stock or fund you're looking at is more volatile than the broader market. Beta measures U. On the contrary. and thus likely flip-flops in the market. By analyzing its message. Beta measures this volatility risk for securities trading in the market. where information about securities is integrated into prices. Basically.S-listed stocks and funds. volatility tends to decline. Higher volatility brings worry to the investors as they watch the value of their portfolios move wildly and decrease in value. when the stock market is climbing. A high reading on the VIX marks periods of higher stock market volatility. Low readings on the VIX mark periods of lower volatility. traders get better understanding of investor's sentiments. On the other hand when the stock market falls. selling when the price of the shares have fallen to a low. Volatility is calculated by a simple mathematical term called beta that shows how volatile the security is compared to the market. This index is important as it works easily with other market indicators. Volatility is often viewed as a negative term in the market that represents uncertainty and risk. there is a greater chance that the stock market is experiencing losses. This indicator helps to ascertain when there is too much optimism or fear in the market. So if you go by above said theory you should be more conscious of the volatility in the market as you make buy and sell decisions. a number of studies have also shown that when volatility rises.Many Investors feel that when volatility is high. You may earn a lot by knowing how to use volatility to your 13 . it's time to buy but when it is low you should not step into market. volatility tends to rise. The Volatility Index (VIX) is the most popular measure of stock market volatility.

you can make money. The most successful investor in the history. So you can make good purchases and make money even when market is dropping. volatility can be good in that if you buy on the lows. However. The key is not to fear and you should make rational decision on when to buy and when to sell the stocks. Volatility provides investment opportunities. Short term market players like day traders hope to make money through volatility. 14 .advantage. Warren Buffet says volatility is not a measure of risk.

95 3418.75 1902.04663 % .00317 % -.08534 % Avg. Index Level Daily Return 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 1212.25 6287.70 931 1124.75 1756 1624. 15 .24440 % .70 924.20754 % .NIFTY Year Max index level Min.5 2632.05239 % .95 4224.06813 % .5 1982.80 3633.45 1146.15 2168.09435 % .00294 % .15606 % -.85 808.65 1198.20 922.6 .70 854.30 1388.

21580 % .05002 % .05568 % .56 5541.33 2764.23833 % .9192 % The daily average return of the Nifty and the Sensex in the year 1998±99 was 0.55 6194.11 6915.02482 % . volatility of Indian currency and the redemption pressures faced by the Unit Trust of India (UTI) in respect of its US±64 Scheme made the Nifty decline from 16 .00294 per cent and -0.16 6134.04 14652.12 2834.96 5933.54 3742.13788 % -.37 -.03 4505.09 20873. woes of East Asian financial markets. The Nifty had positive return whereas the Sensex had negative return.27 3540.86 8929. The pressure of economic sanctions following detonation of nuclear service.01129 % -.65 2600.02482 per cent respectively.09 11307.14112 % -.SENSEX Year Max Index Level Min Index Level Daily Avg Return 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 4280.44 12455.41 2924.16 3245.02 3512.04923 % .

This brought down the Nifty from the height of 1636. the growth rate of manufacturing sector declined to 5. the proposal to increase the tax on distribution of dividend by companies and by MFs from 10 per cent to 20 per cent did not speak well of the corporate sector.vis dollar.6 per cent respectively and within industrial sector. Scams have over and again proved the vulnerability of the regulatory network and system of the finance and capital markets in this year. 17 . Several stockbrokers grossly misused the badla finance given to them by investors. 2000. rising oil prices.82 in April. strength of the Government and also its commitment towards second generation reforms improved macro economic parameters and better corporate results raised the return. 1998 to 808.09435 per cent and -0.43 in October.96 to 2764. devaluation of rupee vis-a. the BSE and the NSE.13788 per cent respectively. In this year the growth rate of GDP and industrial sector was 6.4 per cent to 6 per cent and from 6.The Indian economy decelerated and the Nifty and the Sensex yielded negative return of ±0. The growth rate of GDP and the industrial sector declined from 6.20 in October. 2000 and the Sensex from 5426.2 per cent and the infrastructure sector also registered a lower growth as compared to that of the previous year.95 in April. 2000 to the lower level of 1108.1212.14112 percent respectively.00294 percent to 0.6 per cent to 4.7 in October. There was a large sell off in new economy stocks in global markets.9 per cent respectively.02482 per cent to 0. rising interest rates and inflation. The earth quake in Gujarat.3 per cent. In the year 1999±2000. FIIs investment was very low in that year. Ketan Parek scam in the stock market resulted in a big default in Calcutta Stock Exchange.4 per cent and 6. The union budget of 1999.15606 per cent and -0. the growth rate of manufacturing sector was 7. Within the industrial sector. 2000 to 3689. 1998 and the Senses from 4280. The above cited reasons were the major reasons for the negative returns. the Nifty and the Sensex return increased from 0.75 in April. The trend got reversed during 2000±2001.16.

9 per cent. bomb blast in Ghatkopar area of Mumbai.4070 crore was mobilised as against Rs. The introduction of rolling settlement and derivatives encouraged FIIs and domestic investment even though markets were affected by riots in Gujarat. Further. increase in foreign exchange reserves and exports of Indian companies doubled the Nifty and the Sensex in the first three quarters.7543 crore in 2001±02. Indian Parliament and Jammu and Kashmir Assembly. the FIIs turned as net sellers. All these factors led to the negative return in the Nifty and Sensex. the war between Indo±Pak border and tussle between US and Iraq had negative impact on the stock market. The divestment programme of the public sector units was deferred and PSU stock price declined by 50 per cent. There was a subdued trend in both public and rights issue. Failure of the monsoon. suspension of repurchase facility under UTI¶s US 64 scheme and the attack of World trade Center. the introduction of T+2 settlement 18 . the large expenditure by the Government on infrastructure sector and the reform process enhanced the morale and motivation levels of Corporate India which in turn boosted the stock market returns. Morgan and Stanley Capital International Index value for India declined to 3.0. The year 2002±03 recorded negative return of ±0. The SEBI¶s ban on the Participatory Notes issued by unregulated entities made the markets more disciplined and investor friendly.8660 mn and ±Rs.05568 per cent in the Nifty and Sensex respectively.The year 2001±02 recorded positive return of 0. In addition.00317 per cent but Sensex had negative return of . cyclone in Orisa. In June and October 2002.01129 per cent. The daily average return in the Nifty and the Sensex was the highest in the year 2003±04. Strong economic fundamentals exhibited in the fall in interest rates. strong GDP growth rate.8757 mn respectively. and their investments were ±Rs. In this year a total of Rs. Banks and financial institutions were the main mobilisers during the year.05239 per cent and -0.

There was a decline in the return in the year 2004±2005. to 1388. laying of some institutional foundations for faster development of physical infrastructure. and tax reduction on short term gain.IT index. A new industrial resurgence.5 billion in revenues during fiscal year (April 1 to March 31) 2005-06.45 and 5925. This brought a total halt to all trading and the fund flow to stock market from the retail investors and the Foreign Institutional Investors dwindled.41 billion and Rs.75 and 4505. 19 . But. Money started pouring in from everywhere.In respect of the household sector. They were net sellers in May. By 2005. 2004. a pick up in investment. All these factors boost the Indian stock market scaled high.4%. 2004. a lower circuit breaker was applied on the NSE for the first time.58 respectively on 23rd April 2004. India¶s growth story was well established. The over all performance of the stock markets in the world was well.15 billion in 2005-06. And the biotech sector is growing at 37. the appreciation of rupee against the US dollar.459. the saving in the form of financial and physical assets has gone up from Rs. the margin system and the improved surveillance in the exchanges were also the reasons for the increased return. slow down in Chinese economy. low returns of bank FD rate and insurance policies and negative returns of debt market mutual funds prevented the negative return.42 percent and inched closer to US$ 1. modest inflation in spite of spiraling global crude prices. and the launching of the National Rural Employment Guarantee (NREG) Scheme for inclusive growth and social security increased the return in the year 2005-2006.208. 4. progress in fiscal consolidation.cycle and the derivatives in CNX. rapid growth in exports and imports with a widening of the current account deficit. 4. As the index value of the Nifty sharply came down from 1892.16 respectively in May. Two things have happened in this period to push the market to uncharted territory. tax exemption on long term capital gain. The GDP growth rate was 9.

ferrous metals. oil and gas.9 billion that has flowed into Indian markets in July alone has come from Japanese FIIs. the bulk of the $ 1. both Nifty and Nifty Junior delivered record annual equity returns of 54. at about $8.7 per cent respectively during the calendar year. But this was due to the markets tanking in May and June. were lower by 20 per cent than in 2005. The number of new FIIs registered during the year has also gone up significantly.000 crore).5 billion (around Rs 38. Global crude oil prices were surging yet again and had touched $78 a barrel due to the tensions in West Asia and the hurricanes from the Atlantic into the US east coast of the year further surged in crude prices and oil production and refinery output were disrupted in the affected area. FMCG. The Indian financial sector is on a roll.One is a robust inflow of foreign money.1 and 54. also posted its highest ever absolute gain of 6500 points in over two decades. The year 2007 saw Indian stock markets scaling new peaks. The popular Bombay Stock Exchange (BSE) benchmark index. and auto components did perform wellin that year. Global liquidity had almost been drained off following the rate increases in the US. Amongst NSE indices. Pharma. FII flows in 2006. During 2007-08 the secondary market rose on a point-to-point basis with the Sensex and Nifty rising by 47.8 per cent respectively.23 per cent. It has emerged as the third best performing market in the world with a dollar return of 71. the National Stock Exchange (NSE) has climbed to the top spot in stock futures 20 . What is new about these inflows is the decisive move made by Japanese funds to look at India as an alternative to China. Europe and in Japan.8 per cent and 75. taking the total FII investments in 2005 to around $7 billion. Again there was a decline in the market return in the year 2006-2007. Simultaneously. as more and more FIIs have rushed to pump money into the Indian market. The RBI had also done its bit in doing the same in India and a further movement in that direction cannot but had an adverse impact on the stock market. sensex.

A certain degree of market volatility is unavoidable.contracts and number-two slot in the index futures segment in the world. But frequent and wide stock market variations cause uncertainty about the value of an asset and affect the confidence of the investor. Inter±day volatility of the Nifty and Sensex are given in table Year wise Inter day Volatility for Sensex and Nifty (1998-2008) Year Close Nifty Sensex 21 Open Nifty Sensex . In this study. as the stock price fluctuation indicates changing values across economic activities and it facilitates better resource allocation. Extreme volatility disrupts the smooth functioning of the stock market. even desirable. The risk averse and the risk neutral investors may withdraw from a market at sharp price movements. The overall stock market volatility has fluctuated over the time with no discernible trend and some authors have argued that volatility is higher during the bear markets. VOLATILITY Stock market volatility indicates the degree of price variation between the share prices during a particular period. some general conclusions on common stock risk have emerged from this research. but. The literature on stock market volatility is voluminous. inter±day and intra± day volatility are calculated for each year and for different phases. Spices export from India has reached record levels and exceeded the target set for 2007-08.

2000.642 1.The loss was very high in Sensex compared to Nifty The entire financial year (2000-2001) of the stock market was in the grip of bears.874 2.496 1.922 1.041 1.992 per cent to 2.980 1. the close to close volatility ranged from 0.571 1. The close to close and the open to open volatility in the Sensex was very high in the year 2000-2001. The Nifty recorded negative return and a low volatility in the year 2002±2003.764 2.991 1.776 2.459 1.741 1.151 1.923 2.038 1.025 per cent and 1.758 1.434 1. From 1998 ± 2003 the Sensex values were consistently higher than the values of the Nifty. The close to close volatility in the Nifty was at their peak in 22 .446 .982 1.403 . From 2004-2008 the close to close volatility was very high in Nifty. In the Nifty the open to open volatility was high in the year 1999 .992 1.151 per cent respectively.002 2.914 1.1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 1.801 2.010 per cent to 2.1010 1.038 1.843 1. In the Nifty and in the Sensex.047 1.979 1.991 per cent to 2.069 2.060 1.043 The close to close volatility and the open to open volatility in the Nifty and the Sensex moved in tandem.451 1.2001.041 per cent and 1.047 per cent to 2.232 2.846 per cent respectively.2025 1. In the Sensex the open to open volatility was high in the year 2000. The open to open volatility in the Nifty and the Sensex ranged from 0.644 1.029 1. in both the volatility.516 1.846 1.361 1.

On 3rd September 2007 the value of Sensex was 15422. It follows from equation (2) that matching the observed volatility of the PD ratio under rational expectation requires alternative preference speci. 23 .2007±2008. FACTS This section describes stylized facts of U.33. stock price data and explains why it proved di¢cult to reproduce them using standard rational expectations models. maintaining the assumptions of i:i:d: dividend growth and of a representative agent. As a result circuit breakers were applied on October 16.ca. This explains the development of a large and interesting literature exploring non-time-separability in consumption or consumption habits.05 but on 28th September it was 17291. Indeed.tions.S. In the first half of October 2007 Sensex climbed from 18K to 19K in just four days. The facts presented in this section have been extensively documented in the literature.10. We reproduce them here as a point of reference for our quantitative exercise in the latter part of the paper and using a single and updated data set. The Nifty ranged from 3633.60 to 6287. US job data and interest rate cut by US Fed. Fact1:The PD ratio is very volatile. the behavior of the marginal rate of substitution is the only degree of freedom left to the theorist. higher inflation and political uncertainty over US-Indo nuclear agreement brought a tinge of wariness in the markets.7 It is useful to start looking at the data through the lens of a simple dynamic stochastic endowment economy. Crude oil price affected the market adversely.

This is the avenue pursued in Campbell and Cochrane (1999) who engineer preferences that can match the behavior of the PD ratio we observe in Figure 1.14 Their solution requires. 24 .Fact 2: The PD ratio is persistent. however. as well as other facts not mentioned here. The previous observations suggest that matching the volatility and persistence of the PD ratio under rational expectations would require preferences that give rise to a volatile and persistent marginal rate of substitution. Their speciation also helps in replicating the asset pricing facts mentioned later in this section. imposing a very high degree of relative risk aversion and relies on a rather complicated structure for the habit function .

This is illustrated in Table 2. we relax the rational expectations assumption by replacing the mathematical expectation in equation (2) by the most standard learning algorithm used in the literature. Nevertheless. mainly because the rational expectations model with time separable preferences predicts approximately identical volatilities. which shows the results of regressing future cumulated excess re. Related to this is the observation that the volatility of stock returns in the data is much higher than the volatility of dividend growth see table 1.excessively. These facts have received considerable attention in the literature and are qualitatively related to the behavior of the PD ratio. Fact 3: Stock returns are . While stock returns are difficult to predict in general.turns over different horizons on today¶s price dividend ratio. Instead. the presence of return predictability and the increase in the R2 with the prediction horizon are qualitatively a joint consequence of Fact 2 and i:i:d: dividend growth.In our model we maintain the assumption of standard time-separable consumption preferences with moderate degrees of risk aversion. as we discuss below. the PD ratio is negatively related to future excess stock returns in the long run.16 The observed return volatility has been called . As argued in Cochrane (2005. Before getting into the details of our model. we keep excess return predictability as 25 . Persistence and volatility of the price dividend ratio will then be the result of adjustments in beliefs that are induced by the learning process. we want to mention three additional asset pricing facts about stock returns. chapter 20).18 The absolute value of the parameter estimate and the R2 both increase with the horizon. Starting with the work of Shiller (1981) and LeRoy and Porter (1981) it has been recognized that stock prices are more volatile in the data than in standard models.excessive. volatile. Fact 4: Excess stock returns are predictable over the long-run.

Yet. This contrasts with the habit literature where the movement of stock prices is obtained by modeling the way the observed stochastic process for consumption generates movements in the marginal rate of substitution. we follow more closely the literature in . Finally.averaged over long time spans and measured in real terms . and even though the emphasis of our paper is on moments of the PD ratio and stock returns. In this sense.. it is the learning scheme that delivers the movement in stock prices.tend to be high relative to short-term real bond returns. Cochrane also shows that the absolute value of the regression parameter increases approximately linearly with the prediction horizon. Since this mechanism does not play a significant role in our model. In our model. i. The latter explains why the habit literature focuses on the relationship between particularly low values of consumption and low stock prices. since we are again interested in the quantitative model implications. it is interesting to note that learning also improves the ability of the standard model to match the equity premium puzzle. which shows the average quarterly real return on bonds t being much lower than the corresponding return on stocks Unlike Campbell and Cochrane (1999) we do not include in our list of facts any correlation between stock market data and real variables like consumption or investment. Fact 5: The equity premium puzzle.e.nance. the observation that stock returns . 26 .an independent result. The equity premium puzzle is illustrated in table 1. which is a quantitative result. even in a model with risk neutrality in which the marginal rate of substitution is constant. we abstract from these asset pricing.

This is consistent with Fama¶s (1965) observation that stock returns exhibit volatility clustering where large returns tend to be followed by large returns and small returns by small returns leading to contiguous periods of volatility and stability. Descriptive statistics on Sensex and Nifty returns are summarized in Table 1. For both Sensex and Nifty. It can be seen that returns continuously fluctuate around a mean value that is close to zero. Diagnostic Tests As part of the diagnostics. Subsequently.Statistical Tools The daily and intra-day stock price data have been first processed by using Microsoft Excel. The movements are in the positive as well as negative territory and larger fluctuations tend to cluster together separated by periods of relative calm. the skewness 27 . econometric analysis package EViews has been used to test the return and volatility data for various statistical properties and to estimate ARCH/GARCH class of models. we begin with a visual inspection of the plot of daily returns on Sensex as shown in Figure 1.

Furthermore. the relatively large excess kurtosis suggests that the underlying data is leptokurtic or heavily tailed and sharply peaked about the mean when compared with the normal distribution. 28 . The Jarque-Bera statistic calculated to test the null hypothesis of normality rejects the normality assumption. The results confirm the well-known fact that daily stock returns are not normally distributed but are leptokurtic and skewed.statistic for daily returns is found to be different from zero indicating that the return distribution is not symmetric.

in this case. some degree of clustering is also evident in the plot. It is like constructing moving average of a series. We find that during 1993. 3« 31. and low prices. The simplest of 29 . Before moving on to modeling the conditional volatility as a GARCH process. This graphical presentation reveals that. viz. high. In the next step. day r30 is the average return for the 30-dayperiod under consideration. of late the stock market has become more volatile than what it was at the beginning of the period under study. Moreover. for any date µt. we exclude the first observation and include the 31st observation. we take up a simple exercise to study the inter-temporal pattern of volatility in daily return series during the period of 1993-2003.¶ the variance of daily returns is given by: where. we consider t = 2.94. closing. We can also use other estimators that use easily available information on the stock prices. and 1998 onwards.Behaviour of Volatility Estimates The analyses in the preceding section reveal that the volatility of daily return on Sensex might follow an ARCH or a GARCH process. We compute the variance of the daily returns over a 30-day horizon. The pattern is similar for Nifty also. Thus. The schematic diagram for the 30-day variance of Sensex daily return series is shown in Figure 2. large variations are generally appearing together whereas periods of small variations appear separately. Thus. This way we construct the variance for the remaining period and check whether the variance has changed over time or not. we believe that daily return does not follow a homoscedastic pattern. Our exercise begins with the most commonly used measure of volatility in statistical literature. Hence. daily opening.. 1996-97.

and low prices for arriving at the measure of volatility.these is the classical estimator 2 ) = (Ct . where. Ct is the closing price on day t and Ct-1 on the previous business day. 30 . known as the µextreme-value volatility estimators¶ is proposed by Parkinson (1980). these estimators are more efficient as compared to the classical estimator.Ct-1)2. these estimators take into account the daily opening. In addition to the daily closing price. Due to their superior information content. and Rogers and Satchell (1991). Garman and Klass (1980). high. A different class of volatility estimators.

Graph is given below- Inter and Intra-day volatility So far we have discussed inter-day volatility by computing close to close index level on daily basis.Volatility shown in Indian Markets due to the various Scandals and other circumstances. There 31 . investors. Open to close volatility provide information on change of the prices during the day. these metrics are computed. For many fund managers. intra-day volatility has assumed considerable significance because of its influence on the decision of the market participants and its impact on other instruments such as derivatives. in the recent times. regulators and policy makers. Several metrics are employed to estimate intra-day volatility : (a) open-close index level (b) high low index level and (c) open to open index levels For all the sample countries and for India.

High open to open volatility reveals informational asymmetry and also overflow of information. number of trading hours have been enhanced. Now the market is open for almost 6 ½ hours. open to open and close to close volatility appears to be neck to neck. Therefore. High-low volatility. policy makers and SROs strive to implement policies that smoothen information flow and they also ensure certain measures which ensure bounded extremes with the help of circuit breakers. This is important mainly for India as the trading hours increased over a period of time. It appears that the US also scores over other developed markets in terms of intra-day volatility. is expected to get reflected in the opening prices of shares and on the index. the market was open for about two hours. margin etc. exposure limit.is an elaborate literature to show that volatility is a function of length of time that means. high-low is the highest among the four types of volatility measured as was the case with inter -day volatility. open to open. in the UK 32 . Open to open volatility is very important for several of the participants. one has to keep this in mind while interpreting the results. Significant economic and socio political developments induce price movements and the extent of price movement depend on severity of information. regulators. Therefore. is slightly higher than inter-day volatility and lower than open to close volatilit ies. In the UK. A very high high-low volatility is likely to scare investors and lead sometimes to panic conditions in the market place. Intra-day volatility and developed capital markets In the US. With the implementation of computer screen based trading. intra-day volatility. This indicates smooth flow of information during the day as well as over -night. In the openout-cry system. longer the trading hours higher is the expected volatility. High-low volatility conveys extreme movements and dispersion during the trade time. Later on number of trading hours were extended. Extreme volatility. Any positive or negative information that comes after the close of the market and before the start of the next day¶s trading.

Between BSE Sensex and S&P. Emerging capital markets Emerging markets exhibited higher intra-day volatility compared to developed markets. In the year 2002. Extreme value volatility touched its peak in 2000 at 3. Highlow volatility appears to be very high in Germany. intra-day volatility in India is low. Compared to most of the emerging markets sampled here. Countries like Indonesia. The volatility is on the rise for the past five years. Intra-day volatility in 2003 has been very slightly higher than the 33 . Inter day volatility has been consistently lower than 1 percent and it is half of it in 2002 and 2003. Intra-day volatility for India has been computed for 13 years. is lower than open to open and close to close. CNX. Intra-day dispersion is also high. The volatility in Germany is higher than France. France scored higher volatility compared to the UK and USA. the volatility in the emerging markets is generally on the high side. In India open to open. Brazil experienced very high intra-day volatility and also extreme value volatility followed by Indonesia. South Korea and Mexico. volatility is always higher than close to close volatility and many a times higher than open to close. is the highest among all volatility. Nifty. Among all the emerging countries studied. Nifty appears to be more volatile both in terms of open to close and high low dispersions.17 percent and it continuously slided in the following years and marginally increased to 1. Intra-day and inter -day movements in stock prices are considerably stable in Australia. Australia appears to have comparatively quieter markets. The UK and USA.79 percent in 2002 and it appears to be highest among all the developed markets in that year.69 percent in 2003. It is a sign of an emerging market owing to economic and socio-political variations. did show higher intra-day volatility. Open to close volatility. This observation holds true to both the major exchanges.also. it almost touched 3 percentage points and peaked at 3. Brazil and South Korea. in case of France. 2001 and 2003. Even the high and low price movement variation is also low.

the volatility as per these two parameters in 2003 is only slightly higher compared to 2002. mostly in the popular press. In fact. citing that the intra-day volatility in particular and volatility in general went up in 2003 and more so in the first three months of 2004. but when compared to 2001 and 2000 this is much lower and about 50 percent of what it was in 2000. However. 5 and 6 with regard to open to close volatility and high low volatility reveals that the perceptions are not altogether correct. Only Nifty showed a little more intra-day volatility compared to the previous year and to the Sensex. An attempt has been made to calculate inter and intraday volatility for both Sensex and Nifty with reference to these periods also. In the first 3 months of 34 . they fell down further in 2001 and 2002. A close examination of the Tables 4. although the parameters registered their peak in 2000.immediate preceding years though nothing disturbing is evidenced. Indian Market There have been reports.

High and low volatility ( Volatility Transmission) With a view to finding out the extent of integration and segmentation of market it was decided to identify the top three and bottom three volatility years for each country in the sample. Nifty. The volatility levels are almost identical. Only in case of Nifty. 35 . Charts 3 and 4 provide information on inter and intra-day volatility for both Sensex and Nifty in terms of Indian rupees (not adjusted for $ terms). Open close volatility however. The tables and charts evidently exhibit a close relationship between inter and intraday relationship. This is something very intriguing and deserves micro investigation for the purpose of effective dissemination of information. As per finance theory. Intra-day volatility parameters : open-close and high-low also experienced close togetherness excepting for 1991. in an efficient market both are supposed to be almost the same because the time length is identical and if there are no informational asymmetry then these two parameters converge and have identical volatility. The divergence. If one country (mainly the dominant market) experiences extreme volatility in any given date/given period and if markets are integrated then. Tables 8 and 9. prevailed for the entire period from 1995 to 2003 and they never crossed.2004 volatility calculation reveals that high low volatility slightly went up in January 2004 to 2. The integration between these two parameters is higher in case of Sensex. The results are more or less the same for both the Indian indices. compared to Nifty. From 1998 the indicators traveled nearly together. Close to close and open to open volatility moved in tandem with little divergence in a few periods.10 percent but it is much lower than what was recorded in 2000 and 2001. continuous to be low and although the parameters further receded in February and March 2004. the divergence was little higher and it was highest in 1997. This little divergence was evident from 1997 to 2002.

USA exhibited highest volatility which is also seen in the UK. 1992 and 1993. In 1987. Therefore. If we look at the non-affected countries. When the volatility is stable. it is clear that the negative volatility is highest in 1991. France. sudden change in volatility will affect the sentiments of investors and it will have impact on other markets also. it may be reasonable to conclude that volatility transmits across countries if there is a financial market integration. due to globalization. Australia. For example 36 . It also demands high level of information sharing and also co-ordination so that markets across the globe will have less of volatility or sudden bouts of volatility which is likely to affect investor sentiments.the volatility is expected to get transmitted from one market to another. Malaysia and Thailand. mainly major markets. while rest of the countries did not feel it. From the charts and the tables1. Hong Kong. Negative price movements crossed 15 percent in 1993 and it was about 15 percent and 10 percent in 1991 and 1992 respectively. it was negative volatility. Therefore. Singapore. Extreme volatility analysis (India) Charts for BSE Sensex and NSE Nifty and tables for both the indices are drawn separately with extreme positive and negative price movements. Whenever. Germany. Australia. policy makers and regulators have to be extremely cautious while initiating measures that affects stock prices. they were basically closed or semi-closed markets in 1987 and in some countries such as China. Germany. In other words. Indonesia. Following 10 day price movement have been analyzed to find out the extent of persistence in volatility. such as the UK. Many institutional investors are common throughout the world. the positive volatility is higher than the negative volatility. Thailand and Korea. did not have markets. USA had the lowest volatility in 1995 which is felt in other countries. the volatility was higher. In this analysis highest index movement on any day in a year has been identified.

1 37 . In the popular press. Return squared volatility As far as India is concerned. Even 2002 and 2003. Here one significant assumption is that daily average return is expected to be zero which is by and large true if we examine closely all the data provided in Table 1 for various countries. average volatility for the entire year is calculated and top 5 percent of the returns (in absolute terms) are computed to see the difference between the average and extremes. The depth also is higher for negative volatility. As a fist step. In this procedure there are several pitfalls. many a times. Therefore. here we used a new measurement to compute volatility. As a next step. From the data it is clear that negative variation persist for longer period compared to positive volatility. relative logarithamic return on close index value are used for computing relative return.in 1994. it is found that they have used high-low index levels of the day to compute dispersion and call it volatility. the price variation is higher on positive side compared to negative side. The relative returns are squared and converted into percentage. 1995 and 1996. one more different metric has been computed to measure volatility. also witnessed higher positive variation and the years are relatively more stable.

Sign up to vote on this title
UsefulNot useful