Explaining the Volatility of Aggregate Stock Returns in India with Markov-Switching-Regime-Arch Model

This study examines the behaviour of stock market volatility in India from September 1990 to March 2007 with Cai's6 (1994) Markov-switching-regime-ARCH model. We allow the volatility dynamics to switch among three regimes of high, moderate and low volatility. The ARCH effect significantly comes down on allowing for switching regimes. Therefore, the observed volatility persistence is likely to be a result of switching in volatility regimes. The regime probabilities reveal two major episodes of high volatility - from 1990 to 1992 and from 1997 to 2001. Although, the market has experienced some big volatility shocks since 2002, they were short-lived in nature. During this period, the market has reclined predominantly in low-volatility regime. It seems that major market reforms around this period have produced a structural shift in volatility dynamics.