8 Apeejay Journal of Management and Technology July

C Apeejay Journal of Management and Technology

July 2014, Vol. 9, No. 2, 8-17

ANALYSIS OF STOCK MARKET VOLATILITY:

A COMPARATIVE STUDY OF INDIA AND CHINA

Aparna Bhatia
Binny
Indian capital market has witnessed liberalisation for more than two decades on account of ongoing economic and financial
sector reforms initiated by the Government of India since 1991. The information technology revolution, substantial deregulation
and harmonization has led to increasing free flow of capital across and within markets that has fostered integration. This
market integration has resulted in transmission of volatility from one market to other as well as within markets. The general
concern which is emerging with such developments is the increased volatility of equity returns. The present paper is an attempt
to understand the nature of volatility in Indian and Chinese stock markets and examine the inter linkage between them. The
study uses monthly returns from Bombay Stock Exchange (BSE Sensex) for Indian stock market and Shanghai Stock Exchange
(SSE COMPOSITE) for Chinese stock market respectively from April 01, 2004 to March 31, 2012. The transmission of
volatility between India and China is examined by applying Granger causality test. The results show that the volatility was at
its highest level in the year 2008 in both the countries. However, the Indian stock market is found to be more volatile than
Chinese stock market but returns in Indian stock market were comparatively more than in China.

Keywords: Volatility, Integration, Volatility Transmission, India, China.

INTRODUCTION movement stimulates vulnerability to market

Volatility refers to the amount of uncertainty shocks. Therefore, shocks originating in one market
or risk about the magnitude of changes in security’s not only affect its own market but are also
value. Volatility measures variability of dispersion transmitted to other equity markets. Consequently,
about a central tendency. Glen (1994) defined any information regarding t he economic
volatility as the frequency and magnitude of price fundamentals of one country gets transmitted to
movements. According to Batra (2004), it is a other markets and thus affects other ’s stock
measure of how far current price of an asset markets. Before investing in an asset, investors
deviates from its average past prices. A higher incorporate information about price movements and
volatility means t hat a security’s value can volatility in the same asset and related assets listed
potentially be spread out over a larger range of in different countries. This issue is an important
values. This implies that the price of the security concern for portfolio investors because greater
can change dramatically over a short time period integration among world markets implies stronger
in either direction. Investors perceive high volatility co-movements between markets, thereby nullifying
as a sign of investor nervousness and low volatility much of the gain out of diversification across
as a sign of confidence (Jain and Dash, 2012). borders.
With the advent of globalization, world financial With the rapid growth in the economies of India
markets and economies are increasingly integrated and China, many investors would certainly consider
due to free flow capital and international trade. investing in these two markets rather than in
Globalization has also increased co-movement in developed or other developing markets. However,
stock prices across international markets. This co- the question of whether both markets are integrated

Dr. Aparna Bhatia (author) is Assistant Professor, Department of Commerce, Guru Nanak Dev University, Amritsar,
Punjab. Email: [email protected]
Binny (co-author) is Research Scholar, Department of Commerce, Guru Nanak Dev University, Amritsar, Punjab. Email:
[email protected]
2014 Aparna Bhatia, Binny 9

with each other, so that investing in either India compared to the growth periods. Sarkar et al.
or China will provide a benefit of diversification, (2009) analysed transmission of volatility across
is a major concern for investors. There are several countries leading to volatility while Kang and Yoon
reasons to analyze the cross-border volatility (2012) identified global events responsible for
spillovers. In addition to various domestic factors, increasing volatility in most of the Asian markets.
volatility of major foreign trading partners is one Studies on Stock Market Integration
of the important determinants of stock return The studies on interdependence among equity
volatility in a domestic market. markets are numerous. Majority of the studies have
focused on the interdependence among developed
REVIEW OF LITERATURE and emerging markets, US being the most
Studies on Trends and Reasons Leading to influential.
Volatility Cha and Cheung (1998) examined the impact
The researchers have been working around the of US and Japanese market on Asia’s market and
globe on measuring the reasons of volatility in stock found strong evidence of co-movements among
market. Majority of the studies have focused on world equity markets with the US market playing
one or more factors leading to volatility in stock the leading role. Macdonald (2001) studied the
market. interlinkages among Central and Eastern Europe
Aggarwal et al. (1999) examined the events (CE) stock market indices as a group and three
associated with the sudden shift in volatility of stock developed markets (US, UK and Germany) and
market returns. He found that mostly country found significant long run co-movements among
specific events caused large shift in volatility rather them. Chen et al. (2005) tried to examine the long
than global events or change in exchange rate term linkage between the three pairs of stock
regimes. The only global event that affected most markets namely India – US, China – US and India
of the emerging markets was October 1987 crash. – China. The results revealed that all three pairs
Pal (2005) studied the impact of change in of stock markets were fractionally integrated. It was
trading behaviour of Foreign Institutional Investors found that the linkage between Indian and Chinese
(FIIs) on Indian stock market (BSE Sensex) for stock market was strong during the period of study.
the period (March-June) 2004. He identified herd Bhar and Nikolova (2007) analysed the degree
instinct of investors due t o FIIs movement of integration of the BRIC countries on a regional
responsible for increasing volatility in stock market. and global basis and found that high degree of
Raju and Ghosh (2004) made an international integration exists between the BRIC countries and
comparison of 18 countries by dividing them into their respective regions and lesser with rest of the
developing and developed economies and found world. Kim (2010) investigated the impact of shock
that the returns of markets in India and China were on US stock market to East Asian Economies
as high as that of United States (US) and United namely Hong Kong, Singapore, Korea and Taiwan.
Kingdom (UK) but the volatility of both the The author found that there is a unidirectional
markets was higher. causal relationship between US stock market and
Joshi and Panday (2007) examined the nature East Asian economies running from US to East
of the volatility in the Indian stock markets using Asian economies.
closing prices of S&P CNX Nifty and BSE Sensex Singh (2010) analysed the linkage between
stock prices and concluded that both the stock China and India with four major developed markets
markets exhibited volatility clustering and volatility and concluded that both Indian and Chinese stock
persistence. In a similar study, Kumar (2007) tried market are cointegrated with all the four developed
to measure the quantum and spread of volatility markets and also there exists a bilateral causality
of daily and monthly return with respect to between India and China.
economic growth and concluded that volatility was Fahami (2011) examined the impact of global
higher when economic growth declined as financial crisis on the integration of selected
10 Apeejay Journal of Management and Technology July

developed markets returns namely US, UK, Japan relationship between Indian and Chinese stock
and emerging stock markets of Brazil, Russia, market. The objectives of the current study are:
India, China and evidenced that causality increased 1. To determine the trend in volatility in BSE
during crisis period. Mukherjee (2011) examined Sensex vis a vis SSE Composite.
whether the volatility of stock returns in India is 2. To identify the reasons for volatility in Indian
significantly influenced by the stock market stock market.
volatility of developed and emerging markets. The 3. To determine the causal relation between
results revealed that Republic of Korea and United BSE Sensex and SSE Composite.
States positively influence the Indian stock market
returns while Hong Kong and China negatively DATABASE AND METHODOLOGY
influence the Indian stock market returns. The present study is based on the volatility
Tripathi and Sethi (2012) examined the in BSE Sensex and SSE Composite. BSE Sensex,
interlinkage between India and the advanced the free-float market capitalization based index,
emerging economies i.e Brazil, Hungary, Taiwan, estimated on the basis of 30 stocks is considered
Mexico, Poland and South Africa. The Granger to be the representative of the Indian equity market.
Causality results revealed that short term linkage The SSE Composite Index is stock market indexes
of Indian stock market with the advanced emerging of all stocks (A shares and B shares) that are traded
economies has increased over the period of study. at the Shanghai Stock Exchange, calculated using
Gahlot (2014) studied the nature of volatility and a Paasche weighted composite price index formula.
volatility spillover among South Asian countries. The time period chosen for study is April 2004
He found the existence of bilat eral causal to March 2012. This period has been selected
relationship between India and US, both in short because it represents the period during which the
and long term. Moreover, the recession has been global and the Indian economy has passed through
found to have a higher shock impact on the many ups and downs, thus, affecting the volatility
permanent component of volatility. of the Indian and Chinese stock exchanges. The
The information technology revolution had a monthly closing prices have been taken from the
tremendous impact on the structure of financial BSE website and yahoo finance. From the closing
markets with the quick diffusion of information and prices, returns have been calculated for each month.
the substantial deregulation and harmonization Return is calculated using logarithmic method
which led to increasing flow of capital across and as follows:
within markets that has fostered integration (Gallo rt = (log pt–log pt-1)*100
and Otrando, 2007). This market integration where
provides an opportunity to the investors to diversify rt = Market return at the period t
their portfolio. It also leads to transmission of pt= Price index at day t
volatility from one market to other markets as well pt-1= Price index at day t–1 and
as within markets and causes the linkages between log = Natural log
stock markets around the world to be stronger. Volatility has been calculated as the standard
deviation of the natural log of returns in indices
OBJECTIVES OF THE STUDY for the respective period. Graphs have been used
A lot of research has been done to determine to evaluate the trends in volatility over to facilitate
the linkage between developed and emerging comparison. Separate graphs have been drawn for
markets. However, not much attention has been each individual year of the study and reasons for
given on the detection of the volatility transmission the volatility have been identified from them.
between emerging markets. Hence, this paper is an Granger causality test has also been applied in
attempt to examine the trend in volatility over order to examine the dynamic linkage between
different months in the study period of both the Sensex and its Sectoral Indices. Granger causality
emerging economies and to identify the linkage or test is applied on a stationary series. This test
2014 Aparna Bhatia, Binny 11

analyses the two given factors to identify the cause correlated with each other. Equation (II) postulates
and affect variable. The test is based on following that Y for the current year is related to its own past
two regression equations: values as that of X and next equation (III)
n n postulates a similar behavior of X.
Yt   i X t–i    jYt– j  u1t (I)
i1 j1 RESULTS AND ANALYSIS
n n Trend in Volatility in BSE Sensex Vis-a-Vis SSE
X t   i X t–i   jYt– j  u 2t (II) Composite
i1 j1 The trend in volatility at BSE Sensex and BSE
In the two equations given above it has been Sectoral Indices on monthly basis for the years 2004-
assumed that disturbances u 1t and u 2t are not 05 and 2012-13 has been analysed in Graphs 1-8.

Graph 1. Volatility at BSE and SSE Composite during 2004-05

Source: Author’s graphic representation based on secondary data obtained from www.bseindia.com and http://english.sse.com.cn/

The monthly volatility as shown in Graph 1 on credit and land use. Volatility was high in
indicates that Indian stock market was highly September on account of Government macro-
volatile in May 2004. The trend declined after May economic tightening measures and questions about
2004 till December 2004 and in January, the Chinese accounting standards. The major reason
volatility again shot up. The overall performance for continued slump in the markets was the
of Indian stock market was quite well during the unresolved question of State shares.
year 2014 except for the month of May. However, As shown in Graph 2, the volatility of BSE
the Chinese stock market followed an increasing Sensex declined significantly in 2005-06 in
trend towards the beginning of year till September comparison to previous year. The trend in volatility
2004, after which it started declining. The volatility was inconsistent during the year. The volatility was
was highest in the month of September. Strikingly, highest in October 2005. After October 2005, the
Sensex exhibited more volatility than SSE during volatility followed a declining trend. SSE
the year. Volatility of Sensex was high in May 2004 Composite wit nessed declining trend in the
mainly due to political uncertainty. The prospect beginning of the year. The volatility shot up in the
of a non-BJP government in the center made the month of June. Except for June, the volatility
big players in the stock market nervous about the remained stable throughout the year. Volatility of
continuation of the ongoing reforms in India. In BSE Sensex increased in April on account of the
January, volatility shot up due to general weakness aftermath effects of Union Budget 2005-06. The
in global markets. The volatility of SSE Composite persistent hike in Fed rate, increase in domestic
was high in the beginning, incidental to the inflation, uncertainty regarding international crude
announcement of new policies to restrain out-of- oil prices, three bomb blasts in Delhi were the
control fixed asset investment through restrictions factors responsible for increased volatility. The
12 Apeejay Journal of Management and Technology July

Graph 2. Volatility at BSE and SSE Composite during 2005-06

Source: Author’s graphic representation based on secondary data obtained from www.bseindia.com and http://english.sse.com.cn/

volatility of SSE was quite stable because of Sensex was quite inconsistent with constant ups
number of reforms initiated by the Chinese and downs.
Government in order to protect the interest of Volatility was found to be highest in the month
investor such as elimination of non- tradable shares of June 2006 due to uncertainty in global interest
held by the State or by the politically connected rates, fall in metal prices, inflationary pressures,
institutional investors, issuing of new guidelines to announcement of international sports event (FIFA
encourage listed companies to be more transparent, World cup) and declining trend in the Asian market.
inform investors of their growth strategies, business The volatility of SSE Composite was quite stable
plans and about major events in order to improve till December owing to stock market reforms
governance and strengthen shareholder rights. initiated by China Securit ies Regulatory
As graph 3 shows that BSE Sensex exhibited Commission (CSRC). The volatility shot up
more volatility than that of SSE Composite in the towards the end of financial year in January 2007
beginning of the year but since October the and it was highest in the month of Febuary. The
volatility of SSE Composite was more than that volatility was highest in Febuary on account of fear
of BSE Sensex. The trend in volatility of BSE that Government would raise interest rates in order

Graph 3. Volatility at BSE and SSE Composite during 2006-07

Source: Author’s graphic representation based on secondary data obtained from www.bseindia.com and http://english.sse.com.cn/

to curb inflation and put check on speculative on the other hand. The month-wise volatility in the
trading with borrowed money. benchmark index BSE Sensex was highest in
As shown in Graph 4, the year 2007-08 January 2008 and March 2008 and was lowest
followed an upward trend in equity returns of during May 2007 and June 2007. On the other
Sensex on one hand and increased level of volatility hand, SSE Composite was quite volatile throughout
2014 Aparna Bhatia, Binny 13

Graph 4. Volatility at BSE and SSE Composite during 2007-08

Source: Author’s graphic representation based on secondary data obtained from www.bseindia.com and http://english.sse.com.cn/

the year. The volatility was highest in the month of volatility during the year. Volatility of Sensex
of Febuary. There was increase in returns of Sensex was highest in October 2008. Infact, it was highest
for a major part of the year 2007-08 on account for the total study period while for SSE Composite,
of liquidity support from Foreign Institutional volatility was highest in the month of April. SSE
Investors (FIIs), controlled inflation rate and an plunged a staggering 65% during the year. As far
upward trend in global markets. Volatility shot up as Sensex is concerned, the volatility was high
in January 2008 due to sub-prime losses, slowdown during the year on account of uncertainties in
in world economy led by recession in USA. In international financial markets, concerns of
March 2008, sixth pay commission recommended deepening recession in developed economies, high
a major revision in salaries of all government inflation rates, tightening RBI policies and weak
employees. SSE Composite was quite volatile industrial production data. Global events have been
because of rippling effect of the financial meltdown largely responsible for the rising volatility in the
in the United States, excess liquidity, real estate month of October. In January 2009, a massive
booms and increase in speculative and gambling corporate scandal was witnessed where Satyam’s
activities, overvaluation and low efficiency of listed chairman Ramalinga Raju confessed that the
companies. China’s stock market developed into company’s accounts had been falsified causing huge
a speculative bubble, which lead to the greater loss to the investors. During the same time, SSE
uncertainty and greater provoking losses in the Composite witnessed a volatile trend on account
market. of tightening monetary policy, global economic
Graph 5 reveals that both BSE Sensex and SSE slowdown, pressure of huge freed up non- tradable
Composite witnessed volatile trend during 2008- shares coming into the market and US subprime
09. The markets were characterised by severe bouts mortgage crisis.

Graph 5. Volatility at BSE and SSE Composite during 2008-09

Source: Author’s graphic representation based on secondary data obtained from www.bseindia.com and http://english.sse.com.cn/
14 Apeejay Journal of Management and Technology July
Graph 6. Volatility at BSE And SSE Composite during 2009-10

Source: Author’s graphic representation based on secondary data obtained from www.bseindia.com and http://
english.sse.com.cn/

The volatility of both the indices as shown in market changes to limit speculation. SSE
Graph 6, reduced significantly during the year as Composite gained 80% during the year. However,
compared to the previous year. The market the volatility of Indian stock market was quite
environment improved in 2009-10. Volatility of stable throughout the year except for the month
Sensex was highest during May but declined during of May on account of political uncertainty. May
the later part of the year. SSE exhibited highest 2009 was the most volatile month for BSE Sensex.
volatility in t he month of August as CSRC A positive view of the Government on promissory
approved a variety of investment products and notes, optimistic manufacturing data from China
strategies, margin accounts for trading, stock index and election results were the factors responsible
futures, short selling and also devised some stock for sudden fluctuations among indices.
Graph 7. Volatility at BSE and SSE Composite during 2010-11

Source: Author ’s graphic representation based on secondary data obtained from www.bseindia.com and http://
english.sse.com.cn/

As shown in Graph 7, both the indices exhibited afterwards and shot up in the month of November.
a similar pattern of volatility throughout the year. Volatility of Indian stock market was quite high in
The trend was declining in the beginning and May due to sovereign debt crisis in Greece.
observed inconsistent movements throughout the Volatility somehow reduced till October 2010 but
year but the volatility was lesser as compared to again shot up in February 2011 due to high
the previous year. The volatility of BSE Sensex was inflation, excessive selling by FIIs, and poor growth
highest in May 2010 and February 2011 and was in industrial activities. SSE witnessed high volatility
lowest during July 2010. SSE showed highest during May on growing concerns about Europe
volatility in the month of May which came down debt crisis, real estate speculation and expectations
2014 Aparna Bhatia, Binny 15

that Beijing is going to take swing action to slow up in November as Petro China’s restricted shares,
the nation’s booming economy by raising interest valued at 1.89 trillion Yuan and China National
rates and prevent it from overheating. Volatility shot Petroleum Corporation were made freely tradable.

Graph 8. Volatility at BSE and SSE Composite during 2011-12

Source: Author’s graphic representation based on secondary data obtained from www.bseindia.com and http://
english.sse.com.cn/

Graph 8 reveals that Indian stock market in account of cooling of economic growth, tight
2011-12 witnessed a bearish trend for major part monetary policy, liquidity crunch that prevented
of the year. The volatility declined marginally in SMEs from obtaining credit, falling property prices
2011-12 as compared to the previous year. Sensex and fall in large amount of hidden local Government
had highest volatility in the month of September debt, decline in exports and global policy risks.
but declined afterwards. SSE Composite has Causal Relation between BSE Sensex and SSE
inconsistent up and down movements throughout Composite
the year. It did not do quite well during the year The Granger-causality test was conducted to
and fell by 22% during the year. SSE had highest study the causal relationship between BSE Sensex
volatility towards the end of the financial year in and SSE Composite. Table 1 reflects that there is
January 2012. The Indian stock market had a unidirectional causality between the SSE Composite
bearish trend due to weakening global trend.
and BSE Sensex running from SSE Composite to
Adding to the woes, RBI raised the repo rate 13
times since March 2010 in order to control BSE Sensex. The reported p value at 5% level of
inflation. Also, uncertainties in the financial markets, significance suggests that any variation in Chinese
slowdown in exports due to low growth in US and stock market significantly influences the Indian
Euro area, intensified the risks in Indian stock stock market.
markets. SSE did not do well during the year on Chinese economy is a great provider of natural

Table 1. Granger Causality Results

obs F-Statistic Probability
SSE Composite does not Granger Cause BSE Sensex 94 7.07 0.0014
BSE Sensex does not Granger Cause SSE Composite 0.83 0.0638
Source: Author’s calculations based on secondary data.

and human resources as well as cheap products the dealers. However, the price of these goods is
demanded by the whole world. They work on the 10-70% lower than that of Indian goods owing to
strategy of mass production and mass consumption. low prices, bulk availability and variety. These
This economy is the second largest exporter in the products are dumped into the Indian markets in
world after Germany. Chinese goods are relatively huge quantities which adversely affects the Indian
cheaper, widely available and give huge profit to units. These goods are not only affecting the
16 Apeejay Journal of Management and Technology July

domestic business and Indian market but also the volatility of major foreign trading partners was one
export market of our country. If China’s economy of the important determinants of stock return
slows, it would not just hurt demand and world volatility in a domestic market. Although China’s
prices for raw materials, it would also reduce stock market did not perform well in early 2000,
demand and prices for a range of industrial due to large proportion of non tradable shares, the
materials, like steel. For every dollar’s worth of various reforms initiated by the Chinese government
exports to China, India imports three times from revived the market. SSE Composite was volatile
China. The largest imports from China are in the mainly because of the release of non-tradable shares
indust ry sub-group of radio, television and by the Government, rippling effect of the financial
communication equipment, followed by machinery meltdown in the United States, excess liquidity, real
and equipment, office accounting and computing estate booms and increase in speculative and
machinery, other transport equipment, electrical gambling activities, overvaluation and low efficiency
machinery and apparatus, basic metals, fabricated of listed companies. In India as well, there are a
metal products, except machinery, chemical and number of domestic and global factors that led to
chemical products, motor vehicles, trailers and volatility. The prominent ones being political
semi-trailers, and rubber and plastic products. reasons, economic policies, regulations of the
The two economies have several similarities as government, privatization and globalization, the net
well: they compete in several markets, and they effect of FIIs, civil disturbances in the country as
complement each other in other markets. In several well as outside the country, psychological factors
important sectors, notably textiles, wearing apparel, etc. With increasing integration any shock that
leather, and manufacturing, when China grows, occurs in one market is quickly transmitted to the
India experiences the largest welfare losses. It may other markets. The Granger Causality test reveals
be because of more competition in these sectors. that there is unidirectional causality running from
Growth in other Chinese industries, such as Chinese stock market to Indian stock market.
machinery, transportation and electronic equipment,
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