A Study of Market Efficiency from Option Prices Evidence from the National Stock Exchange of India

Authors

  • Imlak Shaikh Department of Humanities and Social Sciences, Indian Institute of Technology Bombay
  • Puja Padhi Department of Humanities and Social Sciences, Indian Institute of Technology Bombay

DOI:

https://doi.org/10.14665/1614-4007-22-1-005

Keywords:

Implied Volatility, Realized Volatility, Market Efficiency Information Content, Granger causality, Index options BSOPM

Abstract

This paper investigates the market efficiency of S&P CNX Nifty equity index options for at-the-money non-overlapping monthly implied volatilities. Under the rational expectation hypothesis, call and put implied volatilities are calculated using Black and Scholes option pricing-model for the period June, 2001 to May, 2011. The ordinary least squares estimation clearly shows that implied volatility is the best estimate of future realized volatility. An empirical result on Granger causality shows that there is only unidirectional causality prevails in the Indian options market. Granger causality test (Sims and Geweke) indicates that call
and put implied volatility causes the realized volatility but realized volatility cannot cause implied volatility. Granger causality test also confirms that for Indian options market historical volatility does not subsume useful information what already contained in the option price (i.e. implied volatility). The study concludes that volatility estimates based on the option’s price are the best estimate for the future volatility and useful in the pricing of derivatives and portfolio-risk-management.

Published

2015-08-17

Issue

Section

Papers