Ebook Stock Return Volatility Patterns In India
In the aftermath of the many crises that the last decade has been witness to, a return to the old- world order of regulated/restricted flows has been proposed by many economists and policymakers. The clamor for restrictions on capital inflows has largely been on account of the notion that unregulated cross border movement of portfolio capital causes “excessive” booms and busts and thus volatility/instability in the financial markets. Financial market volatility can have a wide repercussion on the economy as a whole. There is clear evidence of the important link between financial market uncertainty and public confidence. Policy makers therefore rely on market estimates of volatility as a barometer of the vulnerability of financial markets.
The existence of excessive volatility or “noise” also undermines the usefulness of stock prices as a “signal” about the true intrinsic value of a firm, a concept that is core to the paradigm of informational efficiency of markets. Further, volatility estimation and forecasting have become a compulsory risk –management exercise for economies and many financial institutions around the world ever since the first Basle Accord was established in 1996. Understanding volatility is therefore central to risk management in an economy.
In the asset pricing literature volatility refers to asset price variability. Volatility may be measured as the standard deviation of daily price changes, or as a by-product of estimation of an econometric volatility model. The standard approach to modeling volatility is through the so-called GARCH class of ARCH models. The availability of long series of asset price data has resulted in a large number of econometric studies on volatility. A general finding across asset markets is that volatility shocks are highly persistent.
In this paper we analyze the time variation in volatility2 in the Indian stock market during 1979-2003. We examine if there has been an increase in volatility persistence in the Indian stock market on account of the process of financial3 liberalization in India. Further, we examine the shifts in stock price volatility and the nature of events that apparently cause the shifts in volatility. This will enable us to identify if a coincidence between the shifts in stock return volatility and financial liberalization exists. We also make an attempt to characterize the evolution of the stock market cycles over time in India and examine if in recent times the stock market cycles have exhibited greater amplitude and volatility. The analysis of bear and bull markets allows us to investigate in greater detail and in an episodic manner, the evolution of stock market instability. In an overall sense, therefore, the aim of this paper is to give economic significance to changes in the pattern of stock market volatility in India during 1979-2003.
Monthly stock returns have been used for analysis as the presence of more noise at higher frequencies makes it difficult to isolate cyclical variations, obscuring thus the analysis of the driving moments of switching behavior in stock price volatility. Asymmetric GARCH model has been used to estimate the element of time variation in volatility. The model is further augmented with dummy variables, an outcome of the structural change analysis, to examine volatility persistence. For the characterization of the stock market cycles, the Pagan and Sussoumov (2003) methodology is adopted.
Contents
Foreword
Abstract
I Introduction
II Theoretical Motivation
III Survey of Literature
IV Data
- IV.1 Basic Data
IV.2 Sample Period
IV.3 Sources of Data
IV.4 Descriptive Statistics
V Estimating Volatility: Exponential GARCH (E-GARCH)
VI The Analysis: Our Approach
- VI.1 NaÔve Model
VI.2 Augmented GARCH Model
VI.3 Characteristics of Stock Market Cycles
VII Conclusions
APPENDIX
References
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