Transmission of funding liquidity shocks in the options market: evidence from India

ABSTRACT

The extant literature examines the interactions between funding liquidity and market volatility on the equity market. This paper extends the literature and investigates the interactions between funding liquidity and market volatility in the options market. The paper employs the Bayesian structural vector autoregression framework to examine the effects of funding liquidity shock to volatility demand, uncertainty, and risk aversion. We find that positive feedback exists between contraction in funding liquidity and volatility demand, uncertainty, and risk-aversion. Our results are robust to alternate specifications of uncertainty and risk-aversion measures, and alternative ordering of variables.

KEYWORDS:

• Funding liquidity
• volatility demand
• uncertainty
• risk-aversion

JEL Classification:

• C11
• G12
• G13

Acknowledgments

The authors gratefully acknowledge the research grant by the Indian Institute of Management Ranchi.

Disclosure statement

No potential conflict of interest was reported by the authors.

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

¹ India VIX is the volatility index of the Indian equity market disseminated by National Stock Exchange (NSE) of India Limited.

² Nifty is the equity market index of National Stock Exchange (NSE) of India Limited.

Additional information

Funding

This work was supported by the Indian Institute of Management Ranchi [Level 2, Seed-Money research].