Sanjay Sehgal Professor of Finance Department of Financial Studies University of Delhi South Campus Tel. 0091-11-27130579 Email: firstname.lastname@example.org Dr. (Mrs.) Namita Rajput Reader in Commerce Sri Aurobindo College (M) University of Delhi Email: email@example.com FUTURE TRADING ACTIVITY AND COMMODITY CASH PRICE VOLATILITY: EVIDENCE FROM INDIA
INTRODUCTION • Organized commodity derivatives in India started in 1875. • However, the introduction of futures resulted in speculation and more cash price volatility in the price levels (which was detrimental to the heath functioning of the underlying commodities), thereby resulting in a ban on the commodity futures in 1952.
As a result commodity derivative market remained dormant for about four decades until government, in a complete change in policy actively encouraged the commodity derivative market. Since 2002 the commodities future market in India has experienced an unprecedented boom in terms of the number of exchanges, number of commodities allowed for derivatives trading as well as the levels of futures trading in commodities
Futures trading in commodities has crossed the $ 1 Trillion mark in 2006 and the growth is so immense that if all goes well, trading account is likely to touch more than $ 5 Trillion mark in coming few years. • At present, in India there are 3 national level electronic regional exchanges for trading commodity derivatives and, as many as 80 commodities are allowed for derivative trading.
OBJECTIVE OF THE STUDY • To examine a lead-lag relationship between: • futures trading activity (volume and open interest) and cash price volatility. • cash price volatility and open interest for major agricultural commodities. • To give a comprehensive picture on a debate over the stabilizing and destabilizing effects of future trading volume in India in relation to selected agricultural commodity future trading in India.
HYPOTHESIS • Studies show, that the introduction of derivatives contracts improves liquidity and reduces informational asymmetries in the market. • In this area, not much work is done in India. Hence, the present study will assess the impact of introducing index futures contracts on the cash price volatility of the underlying agricultural commodity index in India so as to fill the research gap in this area. • The research will also study the stabilizing/ destabilizing effects of future trading volume in India.
The data will consist of daily cash closing prices, daily futures settlement prices, total futures trading volumes (TV), total futures open interest (OI), for selected agricultural commodities such as (wheat, rice oilseed). Cash and futures prices will be recorded and taken on daily basis. (Data* will be taken from mid-2002 to September 2007). *The data to be considered will be from Indian context.
METHODOLOGY USED • Spot market volatility will be estimated using the GARCH model. • Time series of spot market volatility as well as future market volatility and option market liquidity measures will be tested for stationarity. • The association between spot market liquidity and future market volatility will be tested using a suitable causality test. Based on casualty result, we shall try to develop a predictive model.