Indian Stock Market and American Stock Market – A Stockmaxim study

Indian Stock Market and American Stock Market

It is well known that the movements in the stock prices are influenced by the flow of market information. One possible source of this information is movements in other stock markets in the world. There are several reasons why the returns of two different equity markets might be related. The two markets belonging to two different economies might be related to trade and investment, so that any news about economic fundamentals of one country permeates to another and thus affect each other’s equity markets. Given the degree of openness to trade and investment, it is a well-accepted fact that the national markets are interrelated and increasingly

Given the degree of openness to trade and investment, it is a well-accepted fact that the national markets are interrelated and increasingly global. When making decisions, traders incorporate information pertaining to price movements and volatility in the asset they are trading including information about related assets. The movement of markets in rhythm and chorus could nullify much of the gain out of diversification across borders, besides being vulnerable to the caprices of global capital. Thus, understanding how markets influence one another is important in pricing, hedging, and regulatory policy.

In recent years, globalization of capital flows has led to the growing relevance of emerging capital markets and India is one of the countries with an expanding stock market that is increasingly attracting funds from the FIIs1. In particular, deregulation and market liberalization measures, rapid developments in communication technology and computerized trading systems, and increasing activities of multinational corporations have accelerated the growth of Indian capital market, which is now slowly moving towards global financial integration.

From 1999 onwards, Indian firms are raising capital from the US market by listing themselves on US exchanges. At present 12 Indian companies have issued ADRs and are cross-listed in US exchanges and many more companies are planning to cross list in the near future. Moreover, as per the Economic Survey 1999-2000, 23% of Indian exports go to the US and 10% of total Indian imports are from the US making the US the major trading partner of India. Thus it will be interesting to examine the co-movement of Indian stock markets with US markets and the mechanism through which the price changes and volatility are transmitted at the wake of lifting restrictions on capital flows and foreign ownership.

From 1999 onwards, Indian firms are raising capital from the US market by listing themselves on US exchanges. At present 12 Indian companies have issued ADRs and are cross-listed in US exchanges and many more companies are planning to cross list in the near future. Moreover, as per the Economic Survey 1999-2000, 23% of Indian exports go to the US and 10% of total Indian imports are from the US making the US the major trading partner of India. Thus it will be interesting to examine the co-movement of Indian stock markets with US markets and the mechanism through which the price changes and volatility are transmitted at the wake of lifting restrictions on capital flows and foreign ownership.

Three features of these markets motivate our interest in the examination of the short run dynamics of stock returns and volatility between NASDAQ Composite and NSE Nifty. First, the exchanges do not have any overlapping trading hours and hence the case of volatility transmission can be clearly examined. Second, the economic dailies, as well as official publications, have been full of stories of a newfound alliance between the NSE and the NASDAQ. The Economic Times of November 14, 2000, has a story with the headline “Uncertainty in US polls, steep NASDAQ fall triggers crash”, and says, “short-covering by operators and a rebound in the NASDAQ indices reversed the trend on the domestic markets on Tuesday”. A similar report has been echoed in official documents as well. For example, RBIs Annual Report, 2000-2001 has noted that “Market sentiment decline in the NASDAQ index during the second half of the month (November 2000)… .Also affected the market sentiment adversely” (p104). In a similar vein, The Economic Survey, 2000-01 has noted, “….

This erosion in share prices reflected the influence of share price movements abroad, especially at the tech-heavy NASDAQ’ (p 19). Through these news reports, market regulators, traders, and the general investing public in India have become sensitized to market movements in the NASDAQ Composite and its impact on NSE Nifty. Finally, a quick examination of stock market movements of these two markets, during the study period under consideration, suggests that there exists a substantial degree of interdependence between NASDAQ Composite & NSE Nifty indices.

Indian Stock Market and Globalization

The Indian stock market through one of the oldest in Asia being in operation since 1875, remained largely outside the global integration process until the late 1980s. A number of developing countries in concert with the International Finance Corporation and the World Bank took steps in the 1980s to establish and revitalize their stock markets as an effective way of mobilizing and allocation of finance. In line with the global trend, reform of the Indian stock market began with the establishment of Securities and Exchange Board of India in 1988. However, the reform process gained momentum only in the aftermath of the external payments crisis of 1991 followed by the securities scam of 1992.

Among the significant measures of integration, portfolio investment by FIIs allowed since September 1992, has been the turning point for the Indian stock market. As of now, FIIs are allowed to invest in all categories of securities traded in the primary and secondary segments and also in the derivatives segment. The ceiling on aggregate equity of FIIS including NRIs (non-resident Indians) and OCBs (overseas corporate bodies) in a company engaged in activities other than agriculture and plantation has been enhanced in phases from 24 percent to 49 per cent in February 2001.

The change in terms of technology and market practices. Following the commissioning of the NSE in June 1994, National Securities Clearing Corporation in April 1996 and National Securities Depository in November 1996, a screen-based, anonymous, order-driven online dematerialized trading has been the order of the day coupled with improved risk management practices for clearing and settlement. Finally, the process of integration received a major impetus when the Indian corporate was allowed to go global with GDR / ADR issues.

Starting with the maiden issue of Infosys in March 1999, ADR issues has emerged as the star attraction due to its higher global visibility. Till date, around 12 Indian companies have taken advantage of the US market and 76 companies have captured the global market.

In March 2001, two-way fungibility for Indian GDR / ADRs was introduced whereby converted local shares could be reconverted into GDR/ADR subject to sect oral caps. Thus, the Indian stock market, which was in isolation until recently, turns out to have been sensitive to developments in the rest of the world by the end of the 1990s. Besides, India’s cautious experiment with openness appears to have facilitated the steady pursuit of a policy milieu for stock market integration. In this report, we make a symptomatic analysis of the relation between domestic and foreign equity indices. In the next section, we examine the relationship between the US and Indian stock indices and report some stylized facts.

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