SPOT VOLATILITY PREDICTION BY FUTURES AND OPTIONS: AN INDIAN SCENARIO
There are a plethora of studies on the determinants of the spot volatility. The issue of determining spot volatility becomes more convoluted and esoteric when the security concerned also trade-in options and futures markets as its derivative instrument. Most of the research seems to inadequately address the issue of a determinant of spot volatility using only options market and leaves futures market unaccounted for. This paper is an attempt to fill the gap and includes both the markets to determine the spot volatility. Spot volatility measures are regressed on options volume and futures volume using multiple regression analysis. Both the acceptable and popular measures of volatility, GARCH (1,1) estimates, and implied volatility, are used to represent spot volatility. The regression results for options volume as well as futures volume are statistically significant in both the regressions of GARCH (1,1) estimates and implied volatility. This result adds value to the existing lode of knowledge that not only options volume but also the futures volume determines the spot volatility. This is the unique contribution of the present study. Informed investors and equity researchers can reasonably use the findings of this paper to value the shares and predict the future share price, which are the major implications of the study. However, diagnostic testing and model specification is not consistent which are the limitations of the present study. A further study with the improved model specification can be the future scope of the study on the topic.