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An investigation of price discovery and volatility spillovers in India’s foreign exchange market

Sanjay Sehgal (Department of Financial Studies, University of Delhi, Delhi, India)
Wasim Ahmad (Department of Financial Studies, University of Delhi, New Delhi, India AND Department of Finance, College of Business Administration, Salman bin Abdulaziz University, Al-Kharj, Kingdom of Saudi Arabia)
Florent Deisting (Groupe ESC Pau, Pau, France)

Journal of Economic Studies

ISSN: 0144-3585

Article publication date: 11 May 2015

1451

Abstract

Purpose

The purpose of this paper is to examine the price discovery and volatility spillovers in spot and futures prices of four currencies (namely, USD/INR, EURO/INR, GBP/INR and JPY/INR) and between futures prices of both stock exchanges namely, Multi-Commodity Stock Exchange (MCX-SX) and National Stock Exchange (NSE) in India.

Design/methodology/approach

The study applies cointegration test of Johansen’s along with VECM to investigate the price discovery. GARCH-BEKK model is used to examine the volatility spillover between spot and futures and between futures prices. The other two models namely, constant conditional correlation and dynamic conditional correlation are used to demonstrate the constant and time-varying correlations. In order to confirm the volatility spillover results, the study also applies test of directional spillovers suggested by Diebold and Yilmaz (2009, 2012).

Findings

The results of the study show that there is long-term equilibrium relationship between spot and futures and between futures markets. Between futures and spot prices, futures price appears to lead the spot price in the short-run. Volatility spillover results indicate that the movement of volatility spillover takes place from futures to spot in the short-run while spot to futures found in the long-run. However, the results of between futures markets exhibit the dominance of MCX-SX over NSE in terms of volatility spillovers. By and large, the findings of the study indicate the important role of futures market in price discovery as well as volatility spillovers in India’s currency market.

Practical implications

The results highlight the role of futures market in the information transmission process as it appears to assimilate new information quicker than spot market. Hence, policymakers in emerging markets such as India should focus on the development of necessary institutional and fiscal architecture, as well as regulatory reforms, so that the currency market trading platforms can achieve greater liquidity and efficiency.

Originality/value

Due to recent development of currency futures market, there is dearth of literature on this subject. With the apparent importance of currency market in recent time, this study attempts to study the efficient behavior of currency market by way of examining the price discovery and volatility spillovers between spot and futures and between futures prices of four currencies traded on two platforms. The study has strong implications for India’s stock market especially at the time when its currency is under great strain owing to the adverse impact of global financial crisis.

Keywords

Acknowledgements

JEL Classification –G12, G13, C32

The authors would like to thank the editor of this journal and two anonymous referees for their valuable comments and suggestions. The authors would also like to thank Md. Zulquar Nain, Ritesh Kumar Mishra, Mohammad Asif and Shirin Rais for their skilful support. All errors and omissions are solely of the authors.

Citation

Sehgal, S., Ahmad, W. and Deisting, F. (2015), "An investigation of price discovery and volatility spillovers in India’s foreign exchange market", Journal of Economic Studies, Vol. 42 No. 2, pp. 261-284. https://doi.org/10.1108/JES-11-2012-0157

Publisher

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Emerald Group Publishing Limited

Copyright © 2015, Emerald Group Publishing Limited

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