Volatility and the Regulation of Stock Markets: Evidence from South Asia

Volatility and the Regulation of Stock Markets: Evidence from South Asia

Filiz Eryilmaz (Uludag University, Turkey)
Copyright: © 2016 |Pages: 12
DOI: 10.4018/978-1-5225-0004-9.ch008
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In recent years, one of the most important topics related to stock market volatility which is attracting attention, is stock returns, or in other words, the relationship between stock price volatility and trading volume. The aim of this study was to obtain information about the financial market structure of Bangladesh, India, Pakistan by applying Granger Causality Analysis to the relationship of trading volume and stock returns volatility in the period 1980–2012. The study then examines some of the stock market regulations that have been proposed in South Asia to attenuate stock market volatility, which have usually included proposals to limit volatility by imposing temporary trading halts, limiting the legal leverage available to investors in financial assets, altering exchange trading practices to accommodate volume, and by raising the transactions costs of financial trading.
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1. Introduction

Financial market volatility is the volatility shown to the financial market by any asset worth or index in a specific period. Financial market volatility expressed as financial asset yield variability is an important measurement used in the determination of risk of investments in the financial market. Therefore, there has been increasing interest recently in studies related to volatility, which have the same meaning as the concepts of risk and uncertainty, which have an important place in traditional financial theory. When financial markets are effective markets, changes in asset prices and yield of the financial markets reflect the changes in the basic variables of the economy. When the financial markets are not effective, two conditions will arise.

The first is that agents external to economic factors start to affect financial market volatility, such as wrong financial policies and irrational behavior of investors. The second is that this volatility created in the financial markets starts to affect the real economy. In both situations, the volatility observed in the financial markets is an independent indicator of the economic balance and requires intervention by policy-makers. The volatility, which is initially an internal variable, over time starts to affect the economy as a dependent external variable. Financial market volatility showed an increase in general after the 1980s. The most significant reason for this was the increase in worldwide financial liberalization after the 1980s. In this context, the collapse experienced in the USA in October 1987 is extremely noteworthy. Increased financial market volatility is highly significant in respect of both the market investors and the policy-makers. When increased volatility means increased risk for investors, the situation arises where investors may review their investment decisions. In the same way, as a result of increased volatility, policy-makers may fall into the idea that the increased volatility of the financial markets will damage the economy by reflecting the real economy. At the same time, the policy-makers may think that increased financial volatility may damage the financial institutions and the regular functions of the financial market. In this situation, structural and organizational changes may be required to be made by the policy-makers for the market to function more regularly and to increase the flexibility of the market. Therefore, the determination of the causes of the waves experienced in the financial markets and particularly in the stock markets and predictions made by the best modeling are of great importance in respect of both investors and policy-makers.

In recent studies, it has been accepted that there is a connection between the general state of the economy and the financial markets. Especially in developing markets, the general macroeconomic variables of the economy have an effect on securities prices. In financial markets experiencing high volatility, lower risk resources are generally seen as Treasury bonds and foreign currency. Therefore, modeling of the volatility in the financial markets is extremely important in the formation of healthy markets be able to provide depth and flow of resources in the financial markets. When financial market volatility is spoken of, the focus is generally on stock market volatility, which can be considered an indicator of the pricing of stocks not being effective and the financial markets not functioning adequately. There are two reasons why volatility in the stock market has become so important in recent years. The first is that stock market volatility is closely related to the performance of option and derivatives markets, and the second is the financial crisis experienced in the USA on 19 October 1987. At that time, stock prices fell by 40% on average and the fall of 508 points on the Dow Jones Index was a record-breaking crash. This volatility damaged economy transfer channels and caused serious crises in the financial markets. Just as there are negative aspects to stock market volatility, so there can also be said to be positive aspects. Therefore, both the positive and negative directions of stock market volatility should be well considered. Sometimes what can be characterized as positive can also be expressed as negative when volatility is looked at from a different angle. In this sense, with high volatility of stock prices, just as it has been emphasized that the stock may rise excessively, so it can also fall dramatically. Thus, investors with highly volatile stocks may make large profits and when prices fall, may lose large amounts. On the other hand, manipulation to protect investors who are active in the market from volatility risks is one of the negative aspects of volatility and damages the market.

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