You are on page 1of 38


A Major Project Report

Submitted in partial fulfillment of the requirements for BBA (General)

programme of Guru Gobind Singh Indraprastha University, Delhi

Submitted by
Rahul Arora
BBA (Gen) Semester-VI
Enrol. No.: 0651221708

Delhi College of Advanced Studies

B-7, Shanker Garden, Vikaspuri
New Delhi-110018


I hereby declare that the major project report, entitled Volatility in Stock Market, is based on

my original study and has not been submitted earlier for award of any degree or diploma to any

institute or university.

The work of other author(s), wherever used, has been acknowledged at appropriate place(s).

Place: New Delhi Candidates signature

Date: Name: Rahul Arora

Enrol. No.: 0651221708


Name: Ms. Yamini Soi

Supervisor Name: Dr. J.P. Varshney

Delhi College of Advanced Studies Director

Delhi College of Advanced Studies


An independent project is a contradiction in terms. Every project involves contribution of many

people. This project also bears the imprints of many people and it is a pleasure for me to
acknowledge and thank all of them.

I am deeply indebted to Prof. Yamini Soi who acted as a mentor and guide, providing knowledge
and giving me their valuable time out of their busy schedule, at every step throughout the
research. It is only because of him this project came into being.

I also thank the Director of Delhi College of Advanced Studies, for providing an opportunity of
doing this project under his leadership.

I also take the opportunity to express my sincere gratitude to each and every person, who directly
or indirectly helped me throughout the project and without anyone of them the research, would
not have been possible.

The immense learning from this project would be indelible forever.

Student Name


In finance, volatility most frequently refers to the standard deviation of the

continuously compounded returns of a financial instrument within a specific time
horizon. It is common for discussions to talk about the volatility of a security's
price, even while it is the returns' volatility that is being measured. It is used to
quantify the risk of the financial instrument over the specified time period.
Volatility is normally expressed in annualized terms, and it may either be an
absolute number ($5) or a fraction of the mean (5%).

Investors care about volatility for five reasons. 1) The wider the swings in an
investment's price the harder emotionally it is to not worry. 2) When certain cash
flows from selling a security are needed at a specific future date, higher volatility
means a greater chance of a shortfall. 3) Higher volatility of returns while saving
for retirement results in a wider distribution of possible final portfolio values. 4)
Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolio's value. 5) Price volatility presents opportunities to buy
assets cheaply and sell when overpriced.

In today's markets, it is also possible to trade volatility directly, through the use of
derivative securities such as options and variance swaps.

Although the Black Scholes equation assumes predictable constant volatility, none
of these are observed in real markets, and amongst the models are Bruno Dupire's
Local Volatility, Poisson Process where volatility jumps to new levels with a
predictable frequency, and the increasingly popular Heston model of Stochastic

The movement of stock market has always been a puzzle. In past few years stock
market has become quite volatile. It has become quite difficult to predict the erratic
movement shown which is in not at all in tandem with the information which is fed
to stock market. Thus chaos prevails in the markets with investor optimism at
unexpected levels.

Has the stock market volatility increased?

Has the Indian market developed into a speculative bubble due to the
emergence of "New Economy" stocks?
Why is this volatility so pronounced?

The objective of this paper is try to analyze these questions in the context of Indian
stock markets. Its an attempt to unearth the rationale for these weird movements

The Indian Stock Market is well known for its volatility i.e. it is unpredictable and
may work according to demand and supply conditions , Foreign Institutional
Investors Involvment , Mergers , Take overs and acquisitions of the companies etc
may give a a diverse directions to the Indian Stock Market. In this we did a proper
analysis of the several Stocks and try to see the trends that may able to prove that
market give chances to make money at every levels . The stock markets may be
different for traders and investors but both have same motive that is to maximize
the investment. One have to make a better portfolio and keep a record of it to judge
That the chosen company may be able to give better return. It may involve
Quantitative analysis of the Stocks which involve making tables and graphs to
ascertain viability of the company. Stock Market involves the certain exchanges
which help in dealing in stocks such as BSE , NSE.

First of all we examine the fundamentalist view put forward by economists who
argue that volatility can be explained by Efficient Market Hypothesis. A
fundamentalist view says that the stock market react with information flowing in
the stock market. It is the micro and macro economic factors that drives the
market. Trying to examine this fact all the key macro and micro economic factor
growth is being observed with respect to growth in stock market.
On the other hand, the view that volatility is caused by psychological factors is also
tested. A Psychology view states that stock market is more of emotional driven. It
is the perception of the investors that greatly affects the stock market. So We try to
study how the change in habits and perceptions affected the price movements.
What precipitating factors started this remarkable surge, making it crazy? We try to
prove how these perceptual changes have changed volatility through empirical
After that an empirical study of BSE Sensex and a set of representative stocks are
carried out to find the changes in their volatility in the last two years. The stock
market regulation in introduction of rolling settlement and dematerialization as a
measure of reducing volatility is put to test. The study tries to correlate the
economic growth concept with the growth of stock market of India.
Interday Volatility
The variation in share price return between the two trading days is called interday
volatility.Interday volatility is computed by close to close and open to open value
of any index level on a daily basis. Standard deviation is used to calculate inter
day volatility. The interday volatility is calculated byclose to close and open to
open volatility method.
Close to close volatility
For computing close to close volatility, the closing values of the Nifty and Sensex
are taken. Close to close volatility (standard estimation volatility) is measured with
the following formula
Open to open volatility
Open to open volatility is considered necessary for many market participants
because opening prices of shares and the index value reflect any positive or
negative information that arrives after the close of the market and before the start
of the next days trading . Interday volatility takes into account only close to close
and open to open index value and it is measured by standard deviation of returns.
Intraday Volatility
The variation in share price return within the trading day is called intraday
volatility. It indicates how the indices and shares behave in a particular day. Intra
day volatility is calculated with the help of Parkinson Model and Garman and
Klass model.

'Nifty' the glamorous dancing beauty of traditional Indian stock

market. In the recent past this glamorous stock market indicator
dances aggressively. This paper is aimed at throwing lights on
various factors that made our nifty baby to dance fast with lots of
forward steps. Does the movement of Nifty or Nifty really mean
anything to the investors, fund managers, investment advisors,
and last but not the least to the regulators? Do these numbers
have any significance? Do they have any scientific basis? How
does a layman understand these numbers? What exactly that
goes into these numbers? In recent years, indexes have come to
the forefront owing to direct applications in finance in the form of
index funds and index derivatives. Index derivatives allow people
to cheaply alter their risk exposure to an index (hedging) and to
implement forecasts about index movements (speculation).
Hedging using index derivatives has become a central part of risk
management in the modern economy. Securities market indexes
have been constructed to give a quick answer to the question:
What is the-market- doing? What-the-Index-Means? An index is a
number, which measures the change in a set of values over a
period of time. A stock index represents the change in value of a
set of stocks, which constitute the index .More specifically, a stock
index number is the current relative value of a weighted average
of the prices of a pre-defined group of equities. It is a relative
value because it is expressed relative to the weighted average of
prices at some arbitrarily chosen starting date or base period. The
starting value or base of the index is usually set to a number such
as 100 or 1000.Characteristics-of-a-good-IndexA good stock
market index is one, which captures the behavior of the overall
equity market. It should represent the market; it should be well
diversified and yet highly liquid. Movements of the index should
represent the returns obtained by "typical" portfolios in the

India's oldest and first stock exchange: Mumbai (Bombay) Stock

Exchange. Established in 1875. More than 6,000 stocks listed.

Total number of stock exchanges in India: 22

They are in: Ahmedabad, Bangalore, Calcutta, Chennai, Delhi etc.

There is also a National Stock Exchange (NSE) which is located in


There is also an Over The Counter Exchange of India (OTCEI) which

allows listing of small and medium sized companies.

The regulatory agency which oversees the functioning of stock markets is

the Securities and Exchange Board of India (SEBI), which is also located
in Bombay. SEBI's website location is at but you
need a password to access it.

BSE (Bombay Stock Exchange)

The Stock Exchange, Mumbai, popularly known as" BSE" was established in
1875 as "The Native Share and Stock Brokers Association". It is the oldest one
in Asia, even older than the Tokyo Stock Exchange, which was established in
1878. It is the first Stock Exchange in the Country to have obtained permanent
recognition in 1956 from the Govt. of India under the Securities Contracts
(Regulation) Act, 1956.

A Governing Board having 20 directors is the apex body, which decides the
policies and regulates the affairs of the Exchange. The Governing Board consists
of 9 elected directors, who are from the broking comm. Unity (one third of them
retire ever year by rotation), three SEBI nominees, six public representatives and
an Executive Director & Chief Executive Officer and a Chief Operating Officer.

BSE Indices

The launch of SENSEX in 1986 was later followed up in January 1989 by

introduction of BSE National Index (Base: 1983-84 = 100). It comprised 100
stocks listed at five major stock exchanges in India - Mumbai, Calcutta, Delhi,
Ahmedabad and Madras. The BSE National Index was renamed BSE-100 Index
from October 14, 1996 and since then, it is being calculated taking into
consideration only the prices of stocks listed at BSE. BSE launched the dollar-
linked version of BSE-100 index on May 22, 2006. BSE launched two new
index series on 27 May 1994: The 'BSE-200' and the 'DOLLEX-200'. BSE-500
Index and 5 sectoral indices were launched in 1999. In 2001, BSE launched
BSE-PSU Index, DOLLEX-30 and the country's first free-float based index - the
BSE TECk Index. Over the years, BSE shifted all its indices to the free-float
methodology (except BSE-PSU index). BSE disseminates information on the
Price-Earnings Ratio, the Price to Book Value Ratio and the Dividend Yield
Percentage on day-to-day basis of all its major indices. The values of all BSE
indices are updated on real time basis during market hours and displayed
through the BOLT system, BSE website and news wire agencies. All BSE
Indices are reviewed periodically by the BSE Index Committee. This Committee
which comprises eminent independent finance professionals frames the broad
policy guidelines for the development and maintenance of all BSE indices. The
BSE Index Cell carries out the day-to-day maintenance of all indices and
conducts research on development of new indices

NSE (National Stock Exchange)

NSE was incorporated in 1992 and was given recognition as a stock exchange in
April 1993. It started operations in June 1994, with trading on the Wholesale
Debt Market Segment. Subsequently it launched the Capital Market Segment in
November 1994 as a trading platform for equities and the Futures and Options
Segment in June 2000 for various derivative instruments.

NSE Indices

NSE also set up as index services firm known as India Index Services & Products
Limited (IISL) and has launched several stock indices, including:[13]

S&P CNX Nifty(Standard & Poor's CRISIL NSE Index)

CNX Nifty Junior

CNX 100 (= S&P CNX Nifty + CNX Nifty Junior)

S&P CNX 500 (= CNX 100 + 400 major players across 72 industries)

CNX Midcap (introduced on 18 July 2005 replacing CNX Midcap 200)


When we think about stock market, we think about its volatile nature.
Unpredictability is the essential part of the market. Volatility in stock market is the
relative rate at which the price of a security moves up and down. There are many
definations of volatility but in simple words volatility is "the rate and magnitude of
changes in price", it is about how fast prices move. Volatility is low when the
market is quite but moving in range of trade.

Today's market deals directly with volatility through options and variance swaps.
Accounting the annualized standard deviation of daily change in price leads to
evaluation of volatility. In simple terms, if the price of a stock moves up and down
rapidly over short time periods, it has high volatility. If the price almost never
changes, it has low volatility.

Many Investors feel that when volatility is high, it's time to buy but when it is low
you should not step into market. On the contrary, a number of studies have also
shown that when volatility rises, there is a greater chance that the stock market is
experiencing losses. Basically, when the stock market is climbing, volatility tends
to decline. On the other hand when the stock market falls, volatility tends to rise.
So if you go by above said theory you should be more conscious of the volatility in
the market as you make buy and sell decisions.

Volatility is calculated by a simple mathematical term called beta that shows how
volatile the security is compared to the market. Beta measures U.S-listed stocks
and funds. A beta greater than 1 means the stock or fund you're looking at is more
volatile than the broader market. Beta measures this volatility risk for securities
trading in the market, where information about securities is integrated into prices.
The Volatility Index (VIX) is the most popular measure of stock market volatility.
A high reading on the VIX marks periods of higher stock market volatility. Low
readings on the VIX mark periods of lower volatility. This index is important as it
works easily with other market indicators. This indicator helps to ascertain when
there is too much optimism or fear in the market. By analyzing its message, traders
get better understanding of investor's sentiments, and thus likely flip-flops in the

Volatility is often viewed as a negative term in the market that represents

uncertainty and risk. Higher volatility brings worry to the investors as they watch
the value of their portfolios move wildly and decrease in value. Volatility can also
cause investors to respond irrationally, selling when the price of the shares have
fallen to a low. You may earn a lot by knowing how to use volatility to your
advantage. The key is not to fear and you should make rational decision on when to
buy and when to sell the stocks.

However, volatility can be good in that if you buy on the lows, you can make
money. Short term market players like day traders hope to make money through
volatility. The most successful investor in the history, Warren Buffet says volatility
is not a measure of risk. Volatility provides investment opportunities. So you can
make good purchases and make money even when market is dropping.

Year Max index level Min. Index Level Daily Avg.

1998-99 1212.75 808.70 .00294 %
1999-00 1756 931 .15606 %
2000-01 1624.65 1124.70 -.09435 %
2001-02 1198.45 854.20 .00317 %
2002-03 1146.5 922.70 -.05239 %
2003-04 1982.15 924.30 .24440 %
2004-05 2168.95 1388.75 .06813 %
2005-06 3418.95 1902.5 .20754 %
2006-07 4224.25 2632.80 .04663 %
2007-08 6287.85 3633.6 .08534 %

Year Max Index Level Min Index Level Daily Avg

1998-99 4280.96 2764.16 -.02482 %
1999-00 5933.56 3245.27 .14112 %
2000-01 5541.54 3540.65 -.13788 %
2001-02 3742.02 2600.12 -.01129 %
2002-03 3512.55 2834.41 -.05568 %
2003-04 6194.11 2924.03 .23833 %
2004-05 6915.09 4505.16 .04923 %
2005-06 11307.04 6134.86 .21580 %
2006-07 14652.09 8929.44 .05002 %
2007-08 20873.33 12455.37 .9192 %
The daily average return of the Nifty and the Sensex in the year 199899 was
0.00294 per cent and -0.02482 per cent respectively. The Nifty had positive return
whereas the Sensex had negative return. The pressure of economic sanctions
following detonation of nuclear service, woes of East Asian financial markets,
volatility of Indian currency and the redemption pressures faced by the Unit Trust
of India (UTI) in respect of its US64 Scheme made the Nifty decline from
1212.75 in April, 1998 to 808.7 in October, 1998 and the Senses from 4280.96 to
2764.16. In the year 19992000, the Nifty and the Sensex return increased from
0.00294 percent to 0.15606 per cent and -0.02482 per cent to 0.14112 percent
respectively. The union budget of 1999, strength of the Government and also its
commitment towards second generation reforms improved macro economic
parameters and better corporate results raised the return. In this year the growth
rate of GDP and industrial sector was 6.4 per cent and 6.6 per cent respectively and
within industrial sector, the growth rate of manufacturing sector was 7.3 per cent.
The trend got reversed during 20002001.The Indian economy decelerated and the
Nifty and the Sensex yielded negative return of 0.09435 per cent and -0.13788 per
cent respectively. There was a large sell off in new economy stocks in global
markets. This brought down the Nifty from the height of 1636.95 in April, 2000 to
the lower level of 1108.20 in October, 2000 and the Sensex from 5426.82 in April,
2000 to 3689.43 in October, 2000, The growth rate of GDP and the industrial
sector declined from 6.4 per cent to 6 per cent and from 6.6 per cent to 4.9 per cent
respectively. Within the industrial sector, the growth rate of manufacturing sector
declined to 5.2 per cent and the infrastructure sector also registered a lower growth
as compared to that of the previous year.
The earth quake in Gujarat, rising oil prices, devaluation of rupee vis-a- vis dollar,
rising interest rates and inflation, the proposal to increase the tax on distribution of
dividend by companies and by MFs from 10 per cent to 20 per cent did not speak
well of the corporate sector. Scams have over and again proved the vulnerability of
the regulatory network and system of the finance and capital markets in this year.
Ketan Parek scam in the stock market resulted in a big default in Calcutta Stock
Exchange, the BSE and the NSE. Several stockbrokers grossly misused the badla
finance given to them by investors. FIIs investment was very low in that year. The
above cited reasons were the major reasons for the negative returns.
The year 200102 recorded positive return of 0.00317 per cent but Sensex had
negative return of - 0.01129 per cent. The introduction of rolling settlement and
derivatives encouraged FIIs and domestic investment even though markets were
affected by riots in Gujarat, cyclone in Orisa, suspension of repurchase facility
under UTIs US 64 scheme and the attack of World trade Center, Indian Parliament
and Jammu and Kashmir Assembly. The year 200203 recorded negative return of
0.05239 per cent and -0.05568 per cent in the Nifty and Sensex respectively.
Morgan and Stanley Capital International Index value for India declined to 3.9 per
cent. Failure of the monsoon, bomb blast in Ghatkopar area of Mumbai, the war
between IndoPak border and tussle between US and Iraq had negative impact on
the stock market. There was a subdued trend in both public and rights issue. The
divestment programme of the public sector units was deferred
and PSU stock price declined by 50 per cent. In June and October 2002, the FIIs
turned as net sellers, and their investments were Rs.8660 mn and Rs.8757 mn
respectively. In this year a total of Rs.4070 crore was mobilised as against Rs.7543
crore in 200102. Banks and financial institutions were the main mobilisers during
the year. All these factors led to the negative return in the Nifty and Sensex.
The daily average return in the Nifty and the Sensex was the highest in the year
200304. Strong economic fundamentals exhibited in the fall in interest rates,
strong GDP growth rate, increase in foreign exchange reserves and exports of
Indian companies doubled the Nifty and the Sensex in the first three quarters.
Further, the large expenditure by the Government on infrastructure sector and the
reform process enhanced the morale and motivation levels of Corporate India
which in turn boosted the stock market returns. The SEBIs ban on the
Participatory Notes issued by unregulated entities made the markets more
disciplined and investor friendly. In addition, the introduction of T+2 settlement
cycle and the derivatives in CNX.IT index, the margin system and the improved
surveillance in the exchanges were also the reasons for the increased return.
There was a decline in the return in the year 20042005. As the index value of the
Nifty sharply came down from 1892.45 and 5925.58 respectively on 23rd April
2004, to 1388.75 and 4505.16 respectively in May, 2004, a lower circuit breaker
was applied on the NSE for the first time. This brought a total halt to all trading
and the fund flow to stock market from the retail investors and the Foreign
Institutional Investors dwindled. They were net sellers in May, 2004. But, slow
down in Chinese economy, tax exemption on long term capital gain, and tax
reduction on short term gain, the appreciation of rupee against the US dollar, low
returns of bank FD rate and insurance policies and negative returns of debt market
mutual funds prevented the negative return. The over all performance of the stock
markets in the world was well. By 2005, Indias growth story was well established.
Money started pouring in from everywhere. A new industrial resurgence; a pick up
in investment; modest inflation in spite of spiraling global crude prices; rapid
growth in exports and imports with a widening of the current account deficit;
laying of some institutional foundations for faster development of physical
infrastructure; progress in fiscal consolidation; and the launching of the National
Rural Employment Guarantee (NREG) Scheme for inclusive growth and social
security increased the return in the year 2005-2006. And the biotech sector is
growing at 37.42 percent and inched closer to US$ 1.5 billion in revenues during
fiscal year (April 1 to March 31) 2005-06. The GDP growth rate was 9.4%.In
respect of the household sector, the saving in the form of financial and physical
assets has gone up from Rs. 4,208.41 billion and Rs. 4,459.15 billion in 2005-06.
All these factors boost the Indian stock market scaled high. Two things have
happened in this period to push the market to uncharted territory.
One is a robust inflow of foreign money, as more and more FIIs have rushed to
pump money into the Indian market. What is new about these inflows is the
decisive move made by Japanese funds to look at India as an alternative to China,
the bulk of the $ 1.9 billion that has flowed into Indian markets in July alone has
come from Japanese FIIs, taking the total FII investments in 2005 to around $7
billion. The number of new FIIs registered during the year has also gone up
Again there was a decline in the market return in the year 2006-2007. Global crude
oil prices were surging yet again and had touched $78 a barrel due to the tensions
in West Asia and the hurricanes from the Atlantic into the US east coast of the year
further surged in crude prices and oil production and refinery output were disrupted
in the affected area. Global liquidity had almost been drained off following the rate
increases in the US, Europe and in Japan. The RBI had also done its bit in doing
the same in India and a further movement in that direction cannot but had an
adverse impact on the stock market. FII flows in 2006, at about $8.5 billion
(around Rs 38,000 crore), were lower by 20 per cent than in 2005. But this
was due to the markets tanking in May and June. Pharma, ferrous metals, FMCG,
oil and gas, and auto components did perform wellin that year. The year 2007 saw
Indian stock markets scaling new peaks. During 2007-08 the secondary market
rose on a point-to-point basis with the Sensex and Nifty rising by 47.1 and 54.8 per
cent respectively. Amongst NSE indices, both Nifty and Nifty Junior delivered
record annual equity returns of 54.8 per cent and 75.7 per cent respectively during
the calendar year. The Indian financial sector is on a roll. It has emerged as the
third best performing market in the world with a dollar return of 71.23 per cent.
The popular Bombay Stock Exchange (BSE) benchmark index, sensex, also posted
its highest ever absolute gain of 6500 points in over two decades. Simultaneously,
the National Stock Exchange (NSE) has climbed to the top spot in stock futures
contracts and number-two slot in the index futures segment in the world. Spices
export from India has reached record levels and exceeded the target set for 2007-08.

Stock market volatility indicates the degree of price variation between the share
prices during a particular period. A certain degree of market volatility is
unavoidable, even desirable, as the stock price fluctuation indicates changing
values across economic activities and it facilitates better resource allocation. But
frequent and wide stock market variations cause uncertainty about the value of an
asset and affect the confidence of the investor. The risk averse and the risk neutral
investors may withdraw from a market at sharp price movements. Extreme
volatility disrupts the smooth functioning of the stock market. The literature on
stock market volatility is voluminous, but, some general conclusions on common
stock risk have emerged from this research. The overall stock market volatility has
fluctuated over the time with no discernible trend and some authors have argued
that volatility is higher during the bear markets. In this study, interday and intra
day volatility are calculated for each year and for different phases. Interday
volatility of the Nifty and Sensex are given in table
Year wise Inter day Volatility for Sensex and Nifty (1998-2008)

Year Close Open

Nifty Sensex Nifty Sensex
1998-99 1.843 1.979 1.923 2.069
1999-00 1.922 1.874 2.041 2.232
2000-01 1.980 2.151 1.982 2.846
2001-02 1.403 1.516 1.446 1.741
2002-03 .991 1.1010 .992 1.060
2003-04 1.434 1.361 1.451 1.459
2004-05 1.642 1.496 1.644 1.571
2005-06 1.038 1.029 1.038 1.047
2006-07 1.776 1.758 1.801 1.764
2007-08 2.2025 1.914 2.002 2.043

The close to close volatility and the open to open volatility in the Nifty and the
Sensex moved in tandem. In the Nifty and in the Sensex, the close to close
volatility ranged from 0.991 per cent to 2.025 per cent and 1.010 per cent to 2.151
per cent respectively. The open to open volatility in the Nifty and the Sensex
ranged from 0.992 per cent to 2.041 per cent and 1.047 per cent to 2.846 per cent
respectively. The close to close and the open to open volatility in the Sensex was
very high in the year 2000-2001.The loss was very high in Sensex compared to
Nifty The entire financial year (2000-2001) of the stock market was in the grip of
bears. From 1998 2003 the Sensex values were consistently higher than the
values of the Nifty, in both the volatility. From 2004-2008 the close to close
volatility was very high in Nifty. In the Nifty the open to open volatility was high
in the year 1999 - 2000. In the Sensex the open to open volatility was high in the
year 2000- 2001. The Nifty recorded negative return and a low volatility in the
year 20022003. The close to close volatility in the Nifty was at their peak in
20072008. The Nifty ranged from 3633.60 to 6287.33. US job data and interest
rate cut by US Fed, higher inflation and political uncertainty over US-Indo nuclear
agreement brought a tinge of wariness in the markets. Crude oil price affected the
market adversely. On 3rd September 2007 the value of Sensex was 15422.05 but
on 28th September it was 17291.10. In the first half of October 2007 Sensex
climbed from 18K to 19K in just four days. As a result circuit breakers were
applied on October 16.

This section describes stylized facts of U.S. stock price data and explains why it
proved dicult to reproduce them using standard rational expectations models. The
facts presented in this section have been extensively documented in the literature.
We reproduce them here as a point of reference for our quantitative exercise in the
latter part of the paper and using a single and updated data set.7 It is useful to start
looking at the data through the lens of a simple dynamic stochastic endowment
Fact1:The PD ratio is very volatile.
It follows from equation (2) that matching the observed volatility of the PD ratio
under rational expectation requires alternative preference tions. Indeed,
maintaining the assumptions of i:i:d: dividend growth and of a representative
agent, the behavior of the marginal rate of substitution is the only degree of
freedom left to the theorist. This explains the development of a large and
interesting literature exploring non-time-separability in consumption or
consumption habits.
Fact 2: The PD ratio is persistent.
The previous observations suggest that matching the volatility and persistence of
the PD ratio under rational expectations would require preferences that give rise to
a volatile and persistent marginal rate of substitution. This is the avenue pursued in
Campbell and Cochrane (1999) who engineer preferences that can match the
behavior of the PD ratio we observe in Figure 1. Their speciation also helps in
replicating the asset pricing facts mentioned later in this section, as well as other
facts not mentioned here.14 Their solution requires, however, imposing a very high
degree of relative risk aversion and relies on a rather complicated structure for the
habit function .
In our model we maintain the assumption of standard time-separable consumption
preferences with moderate degrees of risk aversion. Instead, we relax the rational
expectations assumption by replacing the mathematical expectation in equation (2)
by the most standard learning algorithm used in the literature. Persistence and
volatility of the price dividend ratio will then be the result of adjustments in beliefs
that are induced by the learning process. Before getting into the details of our
model, we want to mention three additional asset pricing facts about stock returns.
These facts have received considerable attention in the literature and are
qualitatively related to the behavior of the PD ratio, as we discuss below.

Fact 3: Stock returns are .excessively. volatile.

Starting with the work of Shiller (1981) and LeRoy and Porter (1981) it has been
recognized that stock prices are more volatile in the data than in standard models.
Related to this is the observation that the volatility of stock returns in the data is
much higher than the volatility of dividend growth see table 1.16 The observed
return volatility has been called .excessive. mainly because the rational
expectations model with time separable preferences predicts approximately
identical volatilities.
Fact 4: Excess stock returns are predictable over the long-run.
While stock returns are difficult to predict in general, the PD ratio is negatively
related to future excess stock returns in the long run. This is illustrated in Table 2,
which shows the results of regressing future cumulated excess re- turns over
different horizons on todays price dividend ratio.18 The absolute value of the
parameter estimate and the R2 both increase with the horizon. As argued in
Cochrane (2005, chapter 20), the presence of return predictability and the increase
in the R2 with the prediction horizon are qualitatively a joint consequence of Fact
2 and i:i:d: dividend growth. Nevertheless, we keep excess return predictability as
an independent result, since we are again interested in the quantitative model
implications. Yet, Cochrane also shows that the absolute value of the regression
parameter increases approximately linearly with the prediction horizon, which is a
quantitative result.

Fact 5: The equity premium puzzle.

Finally, and even though the emphasis of our paper is on moments of the PD ratio
and stock returns, it is interesting to note that learning also improves the ability of
the standard model to match the equity premium puzzle, i.e., the observation that
stock returns - averaged over long time spans and measured in real terms - tend to
be high relative to short-term real bond returns. The equity premium puzzle is
illustrated in table 1, which shows the average quarterly real return on bonds t
being much lower than the corresponding return on stocks Unlike Campbell and
Cochrane (1999) we do not include in our list of facts any correlation between
stock market data and real variables like consumption or investment. In this sense,
we follow more closely the literature in .nance. In our model, it is the learning
scheme that delivers the movement in stock prices, even in a model with risk
neutrality in which the marginal rate of substitution is constant. This contrasts with
the habit literature where the movement of stock prices is obtained by modeling the
way the observed stochastic process for consumption generates movements in the
marginal rate of substitution. The latter explains why the habit literature focuses on
the relationship between particularly low values of consumption and low stock
prices. Since this mechanism does not play a significant role in our model, we
abstract from these asset pricing.

Statistical Tools
The daily and intra-day stock price data have been first processed by using
Microsoft Excel. Subsequently, econometric analysis package EViews has been
used to test the return and volatility data for various statistical properties and to
estimate ARCH/GARCH class of models.

Diagnostic Tests
As part of the diagnostics, we begin with a visual inspection of the plot of daily
returns on Sensex as shown in Figure 1. It can be seen that returns continuously
fluctuate around a mean value that is close to zero. The movements are in the
positive as well as negative territory and larger fluctuations tend to cluster together
separated by periods of relative calm. This is consistent with Famas (1965)
observation that stock returns exhibit volatility clustering where large returns tend
to be followed by large returns and small returns by small returns leading to
contiguous periods of volatility and stability. Descriptive statistics on Sensex and
Nifty returns are summarized in Table 1. For both Sensex and Nifty, the skewness
statistic for daily returns is found to be different from zero indicating that the return
distribution is not symmetric. Furthermore, the relatively large excess kurtosis
suggests that the underlying data is leptokurtic or heavily tailed and sharply peaked
about the mean when compared with the normal distribution. The Jarque-Bera
statistic calculated to test the null hypothesis of normality rejects the normality
assumption. The results confirm the well-known fact that daily stock returns are
not normally distributed but are leptokurtic and skewed.
Behaviour of Volatility Estimates
The analyses in the preceding section reveal that the volatility of daily return on
Sensex might follow an ARCH or a GARCH process. Hence, we believe that daily
return does not follow a homoscedastic pattern. Before moving on to modeling the
conditional volatility as a GARCH process, we take up a simple exercise to study
the inter-temporal pattern of volatility in daily return series during the period of
1993-2003. Our exercise begins with the most commonly used measure of
volatility in statistical literature. We compute the variance of the daily returns over
a 30-day horizon. Thus, for any date t, the variance of daily returns is given by:

where, day r30 is the average return for the 30-dayperiod under consideration. In
the next step, we exclude the first observation and include the 31st observation.
Thus, in this case, we consider t = 2, 3 31. It is like constructing moving average
of a series. This way we construct the variance for the remaining period and check
whether the variance has changed over time or not. The schematic diagram for the
30-day variance of Sensex daily return series is shown in Figure 2. The pattern is
similar for Nifty also. This graphical presentation reveals that, of late the stock
market has become more volatile than what it was at the beginning of the period
under study. Moreover, some degree of clustering is also evident in the plot. We
find that during 1993- 94, 1996-97, and 1998 onwards, large variations are
generally appearing together whereas periods of small variations appear separately.
We can also use other estimators that use easily available information on the stock
prices, viz., daily opening, closing, high, and low prices. The simplest of
these is the classical estimator 2 ) = (Ct - Ct-1)2; where, Ct is the closing price on
day t and Ct-1 on the previous business day. A different class of volatility
estimators, known as the extreme-value volatility estimators is proposed by
Parkinson (1980), Garman and Klass (1980), and Rogers and Satchell (1991). In
addition to the daily closing price, these estimators take into account the daily
opening, high, and low prices for arriving at the measure of volatility. Due to their
superior information content, these estimators are more efficient as compared to
the classical estimator.
Volatility shown in Indian Markets due to the various Scandals and other
circumstances. Graph is given below-

Inter and Intra-day volatility

So far we have discussed inter-day volatility by computing close to close index
level on daily basis. For many fund managers, investors, regulators and policy
makers, in the recent times, intra-day volatility has assumed considerable
significance because of its influence on the decision of the market participants and
its impact on other instruments such as derivatives. Several metrics are employed
to estimate intra-day volatility :
(a) open-close index level
(b) high low index level and
(c) open to open index levels
For all the sample countries and for India, these metrics are computed. Open to
close volatility provide information on change of the prices during the day. There is
an elaborate literature to show that volatility is a function of length of time that
means, longer the trading hours higher is the expected volatility. This is important
mainly for India as the trading hours increased over a period of time. In the open-
out-cry system, the market was open for about two hours. Later on number of
trading hours were extended. With the implementation of computer screen based
trading, number of trading hours have been enhanced. Now the market is open for
almost 6 hours. Therefore, one has to keep this in mind while interpreting the
results. High-low volatility conveys extreme movements and dispersion during the
trade time. A very high high-low volatility is likely to scare investors and lead
sometimes to panic conditions in the market place. Therefore, regulators, policy
makers and SROs strive to implement policies that smoothen information flow and
they also ensure certain measures which ensure bounded extremes with the help of
circuit breakers, exposure limit, margin etc. Open to open volatility is very
important for several of the participants. High open to open volatility reveals
informational asymmetry and also overflow of information. Any positive or
negative information that comes after the close of the market and before the start of
the next days trading, is expected to get reflected in the opening prices of shares
and on the index. Significant economic and socio political developments induce
price movements and the extent of price movement depend on severity of
information. Intra-day volatility and developed capital markets
In the US, open to open and close to close volatility appears to be neck to neck.
This indicates smooth flow of information during the day as well as over -night.
Extreme volatility, high-low is the highest among the four types of volatility
measured as was the case with inter -day volatility. It appears that the US also
scores over other developed markets in terms of intra-day volatility.
In the UK, intra-day volatility, open to open, is slightly higher than inter-day
volatility and lower than open to close volatilit ies. High-low volatility, in the UK
also, is the highest among all volatility. The volatility is on the rise for the past five
years. France scored higher volatility compared to the UK and USA. Open to close
volatility, in case of France, is lower than open to open and close to close. The
volatility in Germany is higher than France, The UK and USA. Highlow volatility
appears to be very high in Germany. In the year 2002, 2001 and 2003, it almost
touched 3 percentage points and peaked at 3.79 percent in 2002 and it appears to
be highest among all the developed markets in that year. Intra-day dispersion is
also high. Australia appears to have comparatively quieter markets. Intra-day and
inter -day movements in stock prices are considerably stable in Australia. Inter
-day volatility has been consistently lower than 1 percent and it is half of it in 2002
and 2003. Even the high and low price movement variation is also low.
Emerging capital markets
Emerging markets exhibited higher intra-day volatility compared to developed
markets. It is a sign of an emerging market owing to economic and socio-political
variations, the volatility in the emerging markets is generally on the high side.
Countries like Indonesia, Brazil and South Korea, did show higher intra-day
volatility. Among all the emerging countries studied, Brazil experienced very high
intra-day volatility and also extreme value volatility followed by Indonesia, South
Korea and Mexico. Intra-day volatility for India has been computed for 13 years.
Compared to most of the emerging markets sampled here, intra-day volatility in
India is low. Extreme value volatility touched its peak in 2000 at 3.17 percent and
it continuously slided in the following years and marginally increased to 1.69
percent in 2003. Between BSE Sensex and S&P, CNX, Nifty, Nifty appears to be
more volatile both in terms of open to close and high low dispersions. In India
open to open, volatility is always higher than close to close volatility and many a
times higher than open to close. This observation holds true to both the major
exchanges. Intra-day volatility in 2003 has been very slightly higher than the
immediate preceding years though nothing disturbing is evidenced. Only Nifty
showed a little more intra-day volatility compared to the previous year and to the

Indian Market
There have been reports, mostly in the popular press, citing that the intra-day
volatility in particular and volatility in general went up in 2003 and more so in the
first three months of 2004. An attempt has been made to calculate inter and intra-
day volatility for both Sensex and Nifty with reference to these periods also. A
close examination of the Tables 4, 5 and 6 with regard to open to close volatility
and high low volatility reveals that the perceptions are not altogether correct. In
fact, although the parameters registered their peak in 2000, they fell down further
in 2001 and 2002. However, the volatility as per these two parameters in 2003 is
only slightly higher compared to 2002, but when compared to 2001 and 2000 this
is much lower and about 50 percent of what it was in 2000. In the first 3 months of
2004 volatility calculation reveals that high low volatility slightly went up in
January 2004 to 2.10 percent but it is much lower than what was recorded in 2000
and 2001. Open close volatility however, continuous to be low and although the
parameters further receded in February and March 2004. The results are more or
less the same for both the Indian indices. Tables 8 and 9, Charts 3 and 4 provide
information on inter and intra-day volatility for both Sensex and Nifty in terms of
Indian rupees (not adjusted for $ terms). The tables and charts evidently exhibit a
close relationship between inter and intraday relationship. Close to close and open
to open volatility moved in tandem with little divergence in a few periods. This
little divergence was evident from 1997 to 2002. The volatility levels are almost
identical. As per finance theory, in an efficient market both are supposed to be
almost the same because the time length is identical and if there are no
informational asymmetry then these two parameters
converge and have identical volatility. Only in case of Nifty, the divergence was
little higher and it was highest in 1997. From 1998 the indicators traveled nearly
together. Intra-day volatility parameters : open-close and high-low also
experienced close togetherness excepting for 1991. The integration between these
two parameters is higher in case of Sensex, compared to Nifty. The divergence,
Nifty, prevailed for the entire period from 1995 to 2003 and they never crossed.
This is something very intriguing and deserves micro investigation for the purpose
of effective dissemination of information.

High and low volatility ( Volatility Transmission)

With a view to finding out the extent of integration and segmentation of market it
was decided to identify the top three and bottom three volatility years for each
country in the sample. If one country (mainly the dominant market) experiences
extreme volatility in any given date/given period and if markets are integrated then,
the volatility is expected to get transmitted from one market to another. Many
institutional investors are common throughout the world, due to globalization.
Therefore, sudden change in volatility will affect the sentiments of investors and it
will have impact on other markets also. In 1987, USA exhibited highest volatility
which is also seen in the UK, France, Germany, Australia, Hong Kong, Singapore,
Malaysia and Thailand, while rest of the countries did not feel it. If we look at the
non-affected countries, they were basically closed or semi-closed markets in 1987
and in some countries such as China, Indonesia, did not have markets. USA had the
lowest volatility in 1995 which is felt in other countries, mainly major markets,
such as the UK, Germany, Australia, Thailand and Korea. In other words, it may be
reasonable to conclude that volatility transmits across countries if there is a
financial market integration. Therefore, policy makers and regulators have to be
extremely cautious while initiating measures that affects stock prices. It also
demands high level of information sharing and also co-ordination so that markets
across the globe will have less of volatility or sudden bouts of volatility which is
likely to affect investor sentiments.

Extreme volatility analysis (India)

Charts for BSE Sensex and NSE Nifty and tables for both the indices are drawn
separately with extreme positive and negative price movements. In this analysis
highest index movement on any day in a year has been identified. Following 10
day price movement have been analyzed to find out the extent of persistence in
volatility. From the charts and the tables1, it is clear that the negative volatility is
highest in 1991, 1992 and 1993. Negative price movements crossed 15 percent in
1993 and it was about 15 percent and 10 percent in 1991 and 1992 respectively.
Whenever, the volatility was higher, it was negative volatility. When the volatility
is stable, the positive volatility is higher than the negative volatility. For example in
1994, 1995 and 1996, the price variation is higher on positive side compared to
negative side. Even 2002 and 2003, also witnessed higher positive variation and
the years are relatively more stable. From the data it is clear that negative variation
persist for longer period compared to positive volatility. The depth also is higher
for negative volatility.

Return squared volatility

As far as India is concerned, one more different metric has been computed to
measure volatility. In the popular press, many a times, it is found that they have
used high-low index levels of the day to compute dispersion and call it volatility. In
this procedure there are several pitfalls. Therefore, here we used a new
measurement to compute volatility. As a fist step, relative logarithamic return on
close index value are used for computing relative return. The relative returns are
squared and converted into percentage. Here one significant assumption is that
daily average return is expected to be zero which is by and large true if we examine
closely all the data provided in Table 1 for various countries. As a next step,
average volatility for the entire year is calculated and top 5 percent of the returns
(in absolute terms) are computed to see the difference between the average and