In this paper an attempt has been made to assess the impact of recently introduced "options" on the underlying stock of a company in the Indian equity markets. The effect of option introduction on the simple and continuously compounded return volatility, measured by the stock return variance, is examined for the initial 29 stocks on which options were first introduced on July 2, 2001 on the National Stock Exchange (NSE). Numerous studies performed in the developed markets for the same problem have presented contradictory results. The derivatives market is still nascent in India, and so far, to the authors' knowledge, no study has looked into this issue at the individual security level. In this paper, both conditional and marginal return volatilities before and after option introduction are first extracted by fitting appropriate ARMA models for the two periods. Then these models are utilized to investigate any change in marginal volatility using standard large sample tests, such as Wald's test, Likelihood Ratio Test and Lagrange Multiplier Test apart from the usual F-test, which is usually erroneously used, for checking the equality of variances in such situations. However, the change in conditional volatilities is checked using an F-test for comparing two innovation variances. The initial findings suggest that there is no significant change in the `mean' returns. The volatility exhibits a change but the results are not significant, suggesting that option introduction has had no effect on the volatility of the underlying stock.
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