Even though Indian markets have remained volatile in 2022, the market capitalisation of benchmark indices BSE has increased by 137% in December 2022, in comparison with March 2020, the highest among the prominent equity markets, SBI Research said in its latest report.

Returns in BSE Sensex were 4.4 % on a year-to-date basis, with “lesser volatility” as compared to other major equity markets. A granular look at the data reveals that in terms of returns and volatility, Indian markets logged in the best performance on a relative scale.

What are the factors that explain the market volatility in the Indian context? SBI Research finds that, as suggested by the results of the GARCH model, the BSE Sensex returns are not driven by its lag, indicating that Indian markets are forward-looking. But, these returns got impacted by negative news.

"Secondly, an increase in market liquidity has a positive impact on BSE Sensex returns, while VIX index that gauges the market sentiments, especially fear of market participants in the form of 30-day projection of volatility, affects BSE Sensex returns negatively," says the report. 

It adds that a 1-unit (Rs billion) increase in net liquidity increases the BSE Sensex returns by 0.00004 units. "1 unit increase in VIX index de-creases the BSE Sensex returns by 0.01449 unit. Results are significant at 1% level and are also robust."

The report adds that using the estimated volatility of BSE SENSEX returns through the GARCH model, the impact of the federal funds rate, repo rate, and spread of government bond yields was measured on the volatility of BSE Sensex returns, with the help of ARDL model. 

It was found that the federal funds rate and repo rate negatively impacted the BSE Sensex volatility, indicating in a rate hike cycle, market volatility declines as risk gets adequately priced, says the report.

It said 1% increase in FFR and repo rate decreases the volatility of BSE SENSEX returns by 0.244 and 0.346 units, respectively, and the results are found to be significant at a 1% level.

Moreover, a 1% increase in difference (spread) between yields of 5-year government bond yield, with respect to 1-year government bond yield, is found to increase the volatility of BSE Sensex returns by 4.26 units. “This shows the RBI may look at the mid-segment of the yield curve more specifically in terms of signalling,” says the report. 

The report says financial markets in 2022 have remained volatile and edgy, with the central banks globally in unison in a rate hike cycle. "In fact, this is in complete contrast to the post-global financial crisis in 2008 when all central banks had cut rates in unison, but central banks in respective countries decided to take an exit from easy monetary policy separately, India included," says Soumya Kanti Ghosh, group chief economic adviser, SBI Research. 

The note says with the prospect of a global slowdown in 2023, it could be eminently possible that central banks in respective countries start to unwind rates even in unison as inflation comes off the boil and slowdown starts to bite.

It's worth mentioning that equity markets, being the most vital area of the market economy, give access to capital to firms. Some of the largest equity markets are New York Stock Exchange, Nasdaq, Tokyo Stock Exchange, Shanghai Stock Exchange, and Euronext Europe.

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