Study of Joint Dynamics of Returns Volatility and Liquidity

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Date Submitted: 11/21/2012 07:25 AM

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Study of Joint Dynamics of Returns Volatility and Liquidity for Indian Stock Market


Our study explores the joint dynamics of returns, liquidity and volatility in market-capitalization-based portfolios of National Stock Exchange of India.

The primary objective was to study feedback relationship between liquidity and volatility if any and their impact on returns and secondary was to study the spill-over effects of liquidity and volatility on returns across market-capital weighted portfolios.


We build a GARCH model to estimate the volatility of the large and small cap Indices of NSE. We also look at the calendar effects on volatility modelling. We then study the dynamics of the returns, liquidity and volatility for large cap and small cap portfolios respectively using the vector auto-regression model. Lastly we look at the spill-over impact of volatility & liquidity across large and small cap portfolios using the vector auto-regression model and studying the impulse response functions.


We took 10 years of data from National Stock Exchange benchmark indices Nifty 50 and CNX Nifty Junior from 2 may 2002 to 30 Apr 2012. Nifty 50 is the large cap portfolio and CNX Nifty Junior is the small cap portfolio.

The data included daily closing prices & daily traded volume of both large & small cap portfolios.

From the graphical display of data, we can infer:

a) Large cap portfolios has higher volume & liquidity than small cap portfolio

b) Small cap portfolio should have higher liquidity than large cap portfolio as can be seen from the graph that small cap outperformed large cap in bull markets and underperformed large cap in bear markets so volatility in small cap was higher.

Figure 1 – Daily Closing Prices of Large & Small Cap portfolios of NSE

Figure 2 – Daily Volume of Shares traded in Large and Small Cap portfolios


Although many relations in finance rely on the ability of...