The effect of currency futures on volatility of spot exchange rates: Evidence from India

Abstract

This study empirically investigates the effect of currency derivative trading on volatility in spot exchange rates for GBP/INR, JPY/INR, and EURO/INR. Using daily spot exchange rates from October 20th 2005 to 30th October, 2016, ARCH-LM test, GARCH model and GJR GARCH model were applied to the data set. The result reveals that the effect of recent market news on current volatility of exchange rate returns increases and reduces the previous day’s news influencing them during post currency futures. The results from GARCH and GJR GARCH models showed that currency futures trading reduces volatility in spot exchange rate returns of JPY/INR and GBP/INR and increases volatility of exchange rate returns of EURO/ INR during post currency futures period. The result further suggests that there was an asymmetric effect in volatility of spot exchange rate returns.