Market quality, market reforms and investor familiarity: evidence from the Indian stock market

Abstract

The study looks at the impact of three major regulatory changes that happened on the historic day of 2 July 2001, when badla was banned, rolling settlement replaced accounting period settlement for major stocks and same day options were introduced on a selective list of stocks. Further, four months down the line, on 9 November 2001, the Securities Exchange Board of India (SEBI) introduced stock futures on Indian bourses. These dates are very significant for the microstructure of the Indian stock market as SEBI made a coordinated effort to eliminate the bad qualities of badla and accounting period settlement and restored the good qualities of badla. These multiple microstructural and exogenous changes on a single day provide a unique setting to examine their impact on market quality. The study finds that market quality did not improve with this set of changes until the introduction of stock futures, which retain the good qualities of badla.

Notes

1 WG Christie and PH Schultz, “Why Do NASDAQ Market Makers Avoid Odd-Eighth Quotes?” (1994) 49 Journal of Finance1813.

2 J Weston, “Competition on the NASDAQ and the Impact of Recent Market Reforms” (2000) 55 Journal of Finance 2565.

3 The interest rate used to be 2–3% per two weeks and the effective rate will be more than 50% per annum.

4 H Berkman and V Eleswarapu, “Short-term Traders and Liquidity: A Test Using Bombay Stock Exchange Data” (1998) 47 Journal of Financial Economics 339.

5 Before the 1990s there were many instances where badla was banned and reintroduced. After SEBI came into the picture, badla got banned for the first time in December 1993 as badla was linked to the 1992 stock market scam. It was again reintroduced by SEBI in January 1996. Later badla was modified as a computerised service on 10 February 1999 at the National Stock Exchange and on 22 January 2001 at the Bombay Stock Exchange. The ban on 2 July 2001 was significant because, on that day, badla was banned for ever, even in the electronic form, and on the same day an alternative hedging vehicle was introduced.

6 Weston, supra n 2.

7 K Kyriacou and B Mase, “Rolling Settlement and Market Liquidity” (2000) 32 Applied Economics 1029.

8 Berkman and Eleswarapu, supra n 4.

9 Kyriacou and Mase, supra n 7.

10 Y Amihud, H Mendelson and B Lauterbach, “Market Microstructure and Security Values: Evidence from the Tel Aviv Stock Exchange” (1997) 45 Journal of Financial Economics 365.

11 Berkman and Eleswarapu, supra n 4.

12 K Kumar and C Mukhopadhaya, “Impact of Futures Introduction on Underlying Index Volatility: Evidence from India” (2007) 1(1) Journal of Management Science, 26-42.

13 LR Glosten, “Is the Electronic Open Limit Order Book Inevitable?” (1994) 49 Journal of Finance 1127.

14 F de Jong, T Nijman and A Roell, “Price Effects of Trading and Components of the Bid-Ask Spread on the Paris Bourse” (1996) 3 Journal of Empirical Finance 193.

15 J Hasbrouck, “Assessing the Quality of a Security Market: A New Approach to Transaction Cost Measurement” (1993) 6 Review of Financial Studies 191.

Additional information

Notes on contributors

Kiran Kumar Kotha

Kiran Kumar Kotha, Associate Professor, Finance & Accounting Area, IIM Indore, India; [email protected].

Vijaya B Marisetty

Vijaya B Marisetty, Professor, Department of Economics and Finance, BITS Pilani Hyderabad Campus. Email: [email protected].