On The Relationship between Illiquidity, Aggregate Market Return and Conditional Volatility of the NIFTY Index
This study investigated the relationship between daily returns and illiquidity of the NIFTY Index (one of the broad based market indices of the National Stock Exchange of India). In this paper, illiquidity was used as an exogenous variable in the EGARCH (1, 1) framework. The empirical results clearly indicate the presence of a liquidity premium in the National Stock Exchange of India, as evidenced by the positive relationship between illiquidity and returns of the NIFTY Index. They also imply a relationship between liquidity and volatility since illiquidity was used as an exogenous variable in estimating the mean equation and hence it influenced the values of the residuals. The lags of residuals, lags of conditional standard deviation, and lags of conditional variance in turn were inputs in the determination of (the natural logarithm of) conditional variance in the EGARCH framework.
JEL classification: G10; G12; C22.
Keywords: Illiquidity; Return; Conditional Volatility