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The impact of speculation upon volatility and market efficiency: The badla experience on the BSE

  • Ajay Shah

On 12 March 1994, SEBI imposed new norms on trading in the Bombay Stock Exchange, and the effective consequence of this has been an elimination of {\em badla}, a form of forward trading. Without badla, the role of speculative traders on the BSE is diminished. This paper sets out to measure the impact of this elimination of speculative trading upon volatility on the BSE. We explore, and criticise, a variety of different methods of arriving at a conclusion on this question, and present an estimation strategy which exploits the unique opportunity to view this episode as a natural experiment. Our examination of daily unsystematic risk, which takes the value of 3\% in our sample on average, reveals that badla diminishes it by roughly 0.25 percentage points. The statistical significance of this estimate is weak, especially in the light of a qualitative argument suggesting that this estimate is biased upwards. Working with weekly returns data, badla seems to have no impact upon unsystematic risk. On the subject of market efficiency, we find that badla is slightly beneficial for short--horizon market efficiency: the non-forecastability of daily returns of A companies has worsened in the year following 12 March 1994. This effect is concentrated in the short horizon; the degree of forecastability of weekly returns has actually diminished slightly in the year after 12 March 1994.

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Paper provided by EconWPA in its series Finance with number 9507002.

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Date of creation: 11 Jul 1995
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Handle: RePEc:wpa:wuwpfi:9507002
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  1. Ross, S.A., 1989. "Commentary: Using Tax Policy To Curb Speculative Short-Term Trading," Papers t3, Columbia - Center for Futures Markets.
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