Effect of derivatives in improving market stability

Abstract

In this paper we have analyzed low frequency stock data of listed Indian firms, to find if listing on the derivatives market has an impact on the price efficiency. The paper looks at multiple firms selected from small and mid caps, and contrasts certain efficiency metrics of the same firm across two periods – one before listing of options, and one post listing of option. The paper uses the following key metrics – historical volatility, AVAR, Adjusted beta and Amihuds measure. The data suggests that barring certain exceptions, the volatility variance in stock returns increase, suggesting a reduction efficiency. The decision to list an option is taken by the exchanges and is usually an exogeneous decision usually based on how profitable listing a security would be. However, the impact of listing on the stock’s underlying behavior and the markets should also be considered.