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The IUP Journal of Applied Finance
The Impact of Futures Trading on Indian Banking Industry
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Derivatives trading is always at the center of discussion in any financial phenomenon. It has been discussed, argued and defended in many forms as to how the derivatives trading has brought distress and crisis in financial market. While a few derivatives disaster stories were enough to bring the entire business of derivatives under the limelight and make every one worry about unknown risks associated with derivatives, it has gained popularity as a measure of risk mitigation too. This paper explores the impact of futures trading of Bank Nifty Index on the underlying cash market of the sectoral index of Bank Nifty. This is an attempt to study how the onset of futures trading has affected that particular industry in terms of inducing or stabilizing volatility in the spot market. Moreover, the informational efficiency and market integration of the spot market have also been analyzed as a result of futures trading in that segment. GARCH model with futures dummy has been used to analyze the impact of futures trading on spot Bank Nifty Index volatility during the period 2000 to 2013. Two separate GARCH models have been fitted in the pre- and post-futures period to examine the relationship between new information release and spot market volatility following the onset of futures trading. The study has shown that over the time, index futures trading improved the overall performance of the spot market of banking sector by providing better exposure to global factors, by quicker information assimilation, and by reducing the persistence of volatility.

 
 
 

Over the years, the Indian capital market has evolved into a dynamic segment of the Indian financial system. From the historical perspective, the Indian capital market can be divided into four stages since independence. In the first stage of its development, it was strengthened through the establishment of a network of financial institutions such as IFCI (1948), ICICI (1955), IDBI (1964), and UTI (1964). In the second stage, it introduced the Foreign Exchange Regulation Act (FERA, 1973). The third stage of development has been initiated with the emergence of several specialized institutions such as SEBI, CRISIL, CARE, ICRA, SHCIL, IL&FS and OTCEI. Further, during this phase, several committees and working groups have been set up to look after the development and working of the Indian capital market. The fourth stage of development of the Indian capital market refers to the economic reforms initiatives of 1990-91. This phase is termed as a period of change, signifying the widening and deepening of the market. One of the significant reforms during this period was the setting up of the National Stock Exchange (NSE). Another significant development of this phase was marked by the introduction of derivatives trading, based on the recommendations of L C Gupta Committee Report1 (Sarangi and Patnaik, 2007, p. 64).

The advent of stock index futures and options has profoundly changed the nature of trading on stock exchanges. The concern over how trading in futures contracts affects the spot market for underlying assets has been an interesting subject for investors, market makers, academicians, exchanges and regulators alike. These markets offer investors flexibility in altering the composition of their portfolios and in timing their transactions. Futures markets also provide opportunities to hedge the risks involved with holding diversified equity portfolios. As a consequence, significant portions of cash market equity transactions are tied to futures and options market activity (Thenmozhi, 2002, p. 2).

 
 
 

Applied Finance Journal,Informational efficiency, Market integration , Impact of Futures Trading, Indian Banking Industry.