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Behaviour and determinants of implied volatility in Indian market

Narain (Faculty of Management Studies, University of Delhi, Delhi, India)
Narander Kumar Nigam (Shaheed Sukhdev College of Business Studies, University of Delhi, Delhi, India)
Piyush Pandey (Department of Financial Studies, University of Delhi, Delhi, India)

Journal of Advances in Management Research

ISSN: 0972-7981

Article publication date: 7 November 2016

Issue publication date: 7 November 2016

366

Abstract

Purpose

The purpose of this paper is to understand the patterns of the implied volatility (IV) of the Indian index option market and its relationship with moneyness (called the volatility smile). Its goal is also to ascertain the determinants of IV.

Design/methodology/approach

For this purpose, IVs were computed from the daily call and put data of CNX Nifty index options from April 2004 to March 2014. The patterns of IVs were analysed using univariate parametric tests. Multivariate regression analyses were conducted to understand the relationships observed. Resultantly, vector autoregressions were performed to assess the determinants of IV.

Findings

The results suggested that there was asymmetric volatility across time and strike prices using alternative measures of moneyness. Furthermore, it was found that the IV of lower strike prices was significantly higher (lower) than that of higher strike prices for call (put) options. Put IV was observed to be higher than call IV irrespective of any attributes. The results further showed that current-month contracts have significantly higher IV than those for next month and those were followed by far-month contracts. Nifty futures’ volumes and momentum were found to be significant determinants of IV.

Practical implications

The behaviour of the volatility smile is important when accounting for the Vega risks in the portfolios of hedge fund managers. While taking a position, besides the Black-Scholes-Merton (BSM) model’s input factors, investors must consider the previous behaviour of volatility, a market’s microstructures and its liquidity for a put option contract. They must also consider the attributes of the underlying for a call option contract.

Originality/value

This is the first decadal study (the longest span of data for any international study on this subject) to confirm the existence of the volatility smile for the index options market in India. It examines and confirms the smile’s asymmetry patterns for different definitions of moneyness, as well as option types, the tenure of options contracts and the different phases of market conditions. It further helps to identify the determinants of IV and so has renewed importance for traders.

Keywords

Citation

Narain, Nigam, N.K. and Pandey, P. (2016), "Behaviour and determinants of implied volatility in Indian market", Journal of Advances in Management Research, Vol. 13 No. 3, pp. 271-291. https://doi.org/10.1108/JAMR-09-2015-0062

Publisher

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Emerald Group Publishing Limited

Copyright © 2016, Emerald Group Publishing Limited

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