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Financial crises are part and parcel of financial sector development. The gap between risk- bearing capacity and search for higher returns is the common aspect of almost all crises (Das et al., 2012). Crisis that originated from developed market not only affects the country of its origin but also spills over to affect the world economy (Goudarzi and Ramanarayanan, 2011). During a crisis, the stock market registers additional movements that are more than during the normal time and stock prices fall strongly in both developed and developing nations. In stock markets of emerging economies like India, the effects of crisis are rapid and stretched.
A lot of work has been carried out to analyze the relationship between stock returns and volatility, but only a few studies have been carried out to examine the behavior of stock returns during a financial crisis. A majority of this type of research is done in the context of the developed countries. The presence of volatility is most evident during the stock market crashes when a huge turndown in stock prices is associated with a significant increase in market volatility (Wu, 2001).
For instance, the Indian economy has been badly affected by the recent US financial crisis. Following the news of the recession in the US market, Indian financial markets showed a near 60% decline in the index and wiping off of about US$1.3 tn in market capitalization since January 2008 when the Sensex peaked at about 21,000 (Kumar, 2009). The Indian stock market was also affected by earlier crises that occurred elsewhere, but a majority of these crises were not as serious as the recent one that originated from the US.
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