Futures Trading and Spot Market Volatility: A Case of S&P CNX Nifty Index

An attempt is made here to investigate the relationship between stock market volatility and trading activity (trading volume and open interest) in Nifty futures market using the GARCH framework. The study uses daily closing price of Nifty and trading volume, and open interest for Nifty index futures for the period July 1, 2000 to February 28, 2008. The study considers only near-month contract data since most trading activities taken place in this contract. Open interest and volume are used as measures of futures trading activity. The study decomposes series of futures trading volume and open interest into expected and unexpected components by an appropriate ARMA procedure. Then, the study introduces futures trading variables such as expected and unexpected futures volume and open interest in GARCH and GJR GARCH models to examine their effects on spot market volatility. The results show that the spot market volatility bears a positive relationship with unexpected trading volume and open interest in Nifty futures market. But, the same bears a negative relationship with expected futures trading volume and open interest.