Functional Instability or Paradigm Shift?: A Characteristic Study of Indian Stock Market in the First Decade of the New Millennium

78 Pages·2012·0.596 MB·English

by  Amitava Sarkar (auth.)

Functional Instability or Paradigm Shift?

Amitava Sarkar
Functional Instability
or Paradigm Shift?
A Characteristic Study of Indian Stock
Market in the First Decade of the New
Millennium
Amitava Sarkar
School of Management & Sciences
West Bengal University of Technology
BF 142, Salt Lake
Kolkata, West Bengal
India
ISBN 978-81-322-0465-7 e-ISBN 978-81-322-0466-4
DOI 10.1007/978-81-322-0466-4
Springer New Delhi Heidelberg New York Dordrecht London
Library of Congress Control Number: 2012932965
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Preface
The present study investigates the working of the Indian stock market in recent years
and attempts to look for functional instability, if any, embedded in the stock market.
Specifi cally, it explores to discern whether there has been any signifi cant change in
recent years in Indian stock market and the nature and characteristics of such changes,
if any. It chooses the 9-year period from 1999 to 2008. Over this period, stock market
witnessed some major price changes: one in late 1999 that ended in mid-2001,
another that commenced from mid-2004 and a recent one that in effect commenced
from early 2008. The study discerns, among other things, the following.
There is signifi cant volatility in the market with presence of risk premium. There is
asymmetric impact. The market responds more to the negative shocks. Past volatility
affects the market. This study identifi es some volatility transmission channels for
Indian stock market in the domestic sectors. Capital goods sector has remained the
most important and propagator of shocks in SENSEX return. Moreover, shock to
the traditional sectors such as, capital goods and consumer durables sector is likely
to bring about more changes in the market as compared to other sectors. Other sectors,
particularly, the IT sector, have only a mild, almost insignifi cant impact on market
volatility and transmits very little of its volatility to other sectors.
The global stock market is having its infl uence on Indian stock market. The
impact of developed country effect, particularly, that of US stock market, has been
the most prominent. There is some evidence for regional contagion. When we look
at the domestic sectors, we see that capital goods and consumer durables sectors are
the two most predominant sectors. So, it can be said that in India, the traditional
sectors still remain the most important sectors.
The fl ow from real sector to fi nancial sector turns out to be quite weak; some
fl ow from fi nancial sector to real sector could be isolated for the Indian market over
the study period. Along with the presence of volatility, the absence of explanatory
power of fundamental variables in determining stock prices could indeed point
towards vulnerability of Indian stock market in recent years.
Presence of volatility is often regarded as a ‘barometer’ of stock market vulner-
ability. The presence of volatility in Indian stock market and the nature of volatility
transmission from other markets might make one curious about the factors underlying
v
vi Preface
the stock price movement in Indian context. This question is particularly important
because, while excessively volatile stock price could itself be dangerous for an
economy, the risk could increase manifold if the price changes are not based on
economic fundamentals.
Further, these changes in stock market question the functional stability of the
Indian stock market. A sustained spurt might refl ect a paradigm shift, but we should
keep in mind that every bubble seems to be the initiation of a new era. It may well
be the inherent instability or the rather razor-edged stability of the stock market that
helps generate bubbles at regular intervals. The source or driving factor behind such
bubble however might differ. In some cases, bubble may be sector specifi c. However,
it might be spread over the entire economy too.
Stock prices characterized by excessive volatility lack its usefulness as a ‘signal’
about the true intrinsic value of a fi rm there by reducing the informational effi ciency
of the market. Presence of irrational exuberance, herd behaviour with evidence of
strong global and even mild regional contagion and speculation in a market with
excessive volatility might make the situation worse by reducing effi ciency further.
This study is based on the work done under UGC Major Project Scheme
(UGC ref.no.F-5-216/2006 (HRP), January, 2007), during 2007–2010. Dr. Gagari
Chakrabarti, Assistant Professor in Economics, West Bengal Educational Service,
Presidency College, Kolkata, was absorbed as the co-investigator, while Shri Chitrakalpa
Sen worked as the Project Fellow; needless to say, they rendered invaluable service.
Dr. Indranil Mukherjee, my colleague at School of Management and Sciences,
WBUT, provided important statistical and computational ideas. Finally, this book
would not have been successfully completed without the keen interest and continual
and prompt advice of Ms. Sagarika Ghosh, Senior Editor – Business and Economics
at Springer (India) Private Limited. The fi nancial support from University Grants
Commission and the incidental infrastructural support from West Bengal University
of Technology are gratefully acknowledged.
Dr. Amitava Sarkar
Professor and Director
School of Management and Sciences
West Bengal University of Technology, Kolkata
Contents
1 Introduction ............................................................................................... 1
1.1 The Problem and the Issues ............................................................... 1
1.1.1 Origin of the Research Problem ............................................. 3
1.2 Objective of the Project ...................................................................... 5
1.3 Methodology ...................................................................................... 5
1.4 Content Plan of the Study .................................................................. 6
2 Indian Stock Market Movements,
Structural Breaks and Volatility .............................................................. 7
2.1 Introduction ........................................................................................ 7
2.2 The Background ................................................................................. 7
2.3 The Questions .................................................................................... 9
2.4 The Movements in the Stock Market ................................................. 9
2.5 Volatility of Indian Stock Market ....................................................... 11
3 Volatility in Indian Stock Market: Transmission
from Domestic Sectors .............................................................................. 15
3.1 Introduction ........................................................................................ 15
3.2 Earlier Works in the Field .................................................................. 16
3.3 The Analysis ...................................................................................... 17
3.3.1 Testing for Stationarity of Return Series ................................ 19
3.3.2 Estimation of VAR ................................................................. 20
3.3.3 Testing for Granger Causality ................................................ 22
3.3.4 Impulse-Response Function ................................................... 24
3.3.5 Variance Decomposition ........................................................ 30
3.3.6 Conclusion.............................................................................. 35
4 Volatility in Indian Stock Market: Transmission
from Global Markets ................................................................................ 39
4.1 Introduction ........................................................................................ 39
4.2 Earlier Works in the Field .................................................................. 40
4.3 The Analysis ...................................................................................... 41
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viii Contents
4.3.1 Descriptive Statistics .............................................................. 41
4.3.2 Stationarity of Return Series .................................................. 42
4.3.3 Estimation of VAR ................................................................. 43
4.3.4 Testing for Granger Causality ................................................ 43
4.3.5 Impulse-Response Function ................................................... 45
4.3.6 Variance Decomposition ........................................................ 46
4.4 Conclusion ......................................................................................... 47
5 Indian Stock Price Determination:
Fundamental Versus Bubble .................................................................... 49
5.1 Introduction ........................................................................................ 49
5.2 Earlier Works in the Field .................................................................. 50
5.3 Database ............................................................................................. 52
5.4 Methodology ...................................................................................... 53
5.5 Results and Interpretation .................................................................. 53
5.5.1 Checking for Stationarity ....................................................... 53
5.5.2 Results for Applying Vector Auto-Regression ....................... 53
5.5.3 Results of Applying Granger Causality Testing ..................... 53
6 Conclusion ................................................................................................. 57
6.1 Summary of Findings ......................................................................... 57
6.2 Concluding Observations ................................................................... 58
6.3 Scope for Further Research ................................................................ 59
References ........................................................................................................ 61
Index ................................................................................................................. 65
List of Figures
Fig. 2.1 Activity of Indian stock market
(trading volume as a % of GDP) ...................................................... 8
Fig. 2.2 Effi ciency of Indian stock market .................................................... 8
Fig. 2.3 Size of Indian stock market ............................................................. 8
Fig. 2.4 Break points in the BSE SENSEX ................................................... 10
Fig. 2.5 Signifi cant break points in the BSE SENSEX ................................. 10
Fig. 2.6 Twenty-one-day rolling standard
deviation plot of SENSEX return .................................................... 11
Fig. 4.1 RSD SENSEX plot .......................................................................... 42
Fig. 4.2 SENSEX response to global indices ................................................ 45
Fig. 4.3 SENSEX response to domestic sectoral indices .............................. 46
Fig. 4.4 Variance decomposition of SENSEX-global indices ....................... 47
Fig. 4.5 Variance decomposition of SENSEX-sectoral indices .................... 47
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