Hence, it is important to study the effect of the futures on spot market volatility. In 2002, Warren Buffet, the founder of the famous investment company Berkshire Hathaway Inc. and the world richest man in 2008, warned his shareholders about the possible risks stemming from the use of derivatives. He called them ―time bombs, both for the parties that deal in them and the economic system‖ and ―financial weapons of mass destruction‖ (Berkshire Hathaway Inc., 2002., p. 13 and 15). His strong words have got a lot of public and political attention and are willingly cited when the potential negative impact of derivatives is up for discussion. The astonishing growth in derivatives trading since the nineties has given additional support for these …show more content…
In India most derivative traders describe themselves as hedgers and Indian laws generally require derivatives to be used for hedging purpose only (Sarkar, 2006). Although a large part of derivatives trading is mainly used for hedging purposes – the other points are still far from clear, neither theoretically nor empirically. In practice it is very difficult to differentiate a hedger from a speculator. Volatility is difficult to analyze because it means different things to different people. People are rarely precise when they talk about volatility. Also, there is a lot of misinformation about volatility. They consider volatility to be another name for loss. But this is not right. Volatility indicates ups and downs in the prices of securities which could result in either loss or profit. However negative aspect of volatility overpowers the positive aspect. People are more concerned about the loss as a result of volatile …show more content…
It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage is described as risk free because participants are not speculating on market movements. Instead, they bet on the mispricing of a share/asset that has happened between two related markets. Therefore, Arbitrage exists as a result of market inefficiencies. Classical theories suggest that the market, assuming it has rational investors and arbitrageurs, take care of the mispricing and brings back the prices of the assets to their fundamental price. But in reality these mispricing do persist from time to time. So, now the question arises – “Why do the inefficiencies persist?” The answer to this question can be understood from the learnings of the groundbreaking research papers: Shleifer and Vishny (1997) and Barberis and Thaler (2003). These papers discuss about the real-world arbitrage and frictions that are associated with it, which make these inefficiencies to