The Impact of Speculation Upon Volatility and Market Efficiency : The Badla Experience on the Bse

On 12 March 1994, SEBI imposed new norms on trading on the Bombay Stock Exchange, and the effective consequence of this has been an elimination of 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. 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 most pronounced in a short horizon; the degree of forecastability of weekly returns is essentially unchanged in the year after 12 March 1994. Obtaining from mail server: send email to mserver@cmie.ernet.in with these two lines in the body: get sigfi badla1.uue get sigfi badla2.uue The file badla1.uue uudecodes into piece.aa The file badla2.uue uudecodes into piece.ab Concatenate these two to get the file paper.ps.gz