ADRs are negotiable certificates,which represent the ownership of foreign corporations and are traded in the U.S stock market. As a potential alternative to direct investment in foreign stocks,ADRs have become popular tools for international diversification. In our paper,we focus on the price transmission mechanism amongst the ADR and it¡¦s pricing factors as well as the global diversification effect of ADRs. Specifically,three topics are examined in our paper¡R First we apply several multiple regression models to identify what factors affect ADR returns and the returns on underlying stocks. These factors we used to incorporated included foreign exchange rate, S&P 500 Index and world Index. Due to possible common factors not incorporated in our models, we apply SUR to yield more robust results. Second, we apply VAR to investigate how ADR returns and returns on underlying stocks interrelated and augmented by lagged U.S. equity index and world index on a daily basis. Finally, we apply vector-error-correction model to investigate how ADR returns and returns on underlying stocks interrelated with deviations from long run relationships. We first implement Augmented Dickey-Fuller tests to see if they are integrated of the same order. The residuals are then used as error-correcting terms for VECM. Due to the fact that these markets do not close synchronously, VECM with different error correcting terms documented in this study does provide important information regarding how ADR or stock returns react to the deviations from the long-run equilibrium.

The impact of the introduction of derivatives on the underlying stock is a debatable topic among the researchers. The issue is quite controversial as contradictory results have been obtained by researchers in various stock markets. The purpose of this study is to examine the volatility and the liquidity effect on the underlying stock after the introduction of index options. We have investigated volatility and liquidity effect by collecting sample data from the stock markets of India, Korea, Taiwan, Hong Kong, Japan, Thailand, Malaysia and Singapore, only markets which are offering index options in Asia.   Applying the generalized autoregressive conditional heteroscedasticity (GARCH) model, we have examined the conditional volatility of intraday (high frequency) returns for each stock market, before and after the introduction of index options. We have also examined the liquidity effect through t-test and Wilcoxon Signed Rank Test. We used t-test to determine the mean differences between the trading volume of pre-index and post-index options periods.    By comparing the estimated parameters and the coefficient of conditional volatility in pre and post period of index options introductions, we have examined that the derivatives trading dramatically increases the persistence of the conditional volatility for all the selected stock markets. We also observed mixed evidence in context to liquidity effect. In the stock exchanges of Hong Kong, Japan, Korea, Taiwan and Thailand, we found that the respective markets become more liquid in the post index options periods in contrast to pre index options period. In these markets trading volume increased significantly after the introduction of index options.  On the other hand, India, Malaysia and Singapore stock markets show no liquidity effect in the post-index option period.   Finally, the empirical results of our study conclude that the introduction of index options on the selected Asian stock markets have increased in stock return volatility and liquidity on the underlying stocks.

Financial Derivatives are one of the most popular and emerging innovations in the field of financial engineering. Since their inception, there has been a phenomenal growth in the volumes of derivatives traded all over the world. Financial markets are known to be extremely volatile and derivatives provide a way of eliminating or reducing the risks involved in these markets. Since these instruments derive their value from some underlying asset, trading in these instruments is bound to affect the underlying assets. Thus it becomes important to examine what these effects are and whether they have been favourable or detrimental to the underlying stock markets specially when there has been an explosive growth of these financial derivatives all over the world. This issue gains more importance in the case of emerging markets like India as they try to be more competitive and efficient as the developed Western markets. This thesis mainly deals with looking at this impact on the Indian stock markets. The Indian markets still being very new in this area, not many studies have been reported here related to this issue. The main focus of this thesis is to provide some more evidence on the impact of one kind of derivative instrument, namely options on different characteristics of underlying stocks in the Indian stock market. The thesis has the following objectives: • To examine the impact of option introduction on the price of underlying stocks in National Stock Exchange (NSE). • To examine the impact of option introduction on the volatility of underlying stocks in NSE • To examine the impact of option introduction on liquidity of underlying stocks in NSE NSE introduced derivatives beginning with index futures on June 12, 2000, followed by index options on June 4, 2001, options on individual securities on July 2, 2001 and finally futures on individual securities on November 9, 2001. Due to the temporal proximity of the introduction of index options and individual options, there exists a possibility of an interaction of these two effects. This problem is solved by a judiciously chosen sampling design. In particular, three groups of stocks are considered. The first group consists of stocks on which options were first introduced on 2nd July 2001 and thus would exhibit a combined effect of the two events if any. The second group consists of stocks on which options were introduced much later and therefore would show effects of individual option introduction if any. The third group comprises of nonoptioned stocks whose returns are considered around the date of index option introduction and thus would show effects of index option alone if any. To separate the two effects an ANOVA/ Logistic Regression model is used. An objective selection of the event and estimation windows is done using a Bayesian Change Point Analysis. The first part of the thesis looks at the effect of option introduction on the price of underlying stocks. A standard event study methodology as has been used in the literature is employed for this purpose. The study does not find any significant effect of option introduction on the prices. The second part of the thesis deals with the effect on volatility. Volatility is measured as the risk of a stock and as is done in the literature, three kinds of risk are looked at: total risk, systematic risk and the unsystematic risk. In case of the total risk, an F-test and an Ansari Bradley test is used to check for changes in the variance and scale parameters of market-adjusted continuously compounded returns of the stocks before and after option introduction. The results of these tests are recorded as a categorical variable taking on the value 0 for no change and 1 for a change and a Binomial Logistic Regression is used to separate the effects of the two events. Furthermore, after recording the results of the above mentioned tests as a categorical variable with three categories (0, 1, -1), a Multinomial Logistic Regression is also used in order to estimate the direction of the change (increase, decrease or no change). The ratios of after to before total risks are also analyzed using an ANOVA model. The systematic risk is measured using three kinds of betas – OLS betas, Scholes-Williams betas and Fowler-Rorke betas. The differences in the before and after betas of every stock are modelled using an ANOVA model in order to separate the two effects as well as the interaction effect. The unsystematic risk is estimated by the conditional variances and the unconditional variances of ARMA and ARMA-GARCH models fitted to market model excess returns. The ANOVA model is used here as well. In addition to this, the before and after ARCH and GARCH coefficients of GARCH (1, 1) models fitted to the excess returns are also compared using the ANOVA model. The results indicate that individual options are leading to a decline in total risk however index options are causing an increase in total risk. The interaction effect is significant in this case thereby causing an increase in total risk in the Group I stocks. The OLS betas indicate that individual option introduction seems to have increased the systematic risk. The Scholes-Williams betas indicate that index option introduction seems to have increased the systematic risk. The Fowler Rorke betas on the other hand, do not show any significant impact of individual option or index option introduction. For all the three betas index options introduction seems to have no effect on the systematic risk. Though the interaction effect seems to be significant in all the three cases, it however does not significantly affect the systematic risk in Group I stocks. As regards the unsystematic risk, both the conditional and unconditional variances of ARMA models show a significant reduction for individual option introduction but index options do not have any significant impact on either one of these measures. In case of unconditional variances of ARMA-GARCH models, none of the effects come out as significant. While comparing the news and persistence coefficients of GARCH (1, 1) models, the news coefficients indicate that the due to index option introduction, stocks are becoming more efficient in terms of absorbing the news more rapidly. No significant effect of either event is found on the persistence coefficients. The last part of the thesis deals with the liquidity issue. Liquidity has been measured using two measures – relative volume (based on daily data) and implicit bid-ask spread given by Roll (1984) (calculated from intra-day data). In case of the liquidity measures, the Logistic Regression models are used i.e. a categorical variable with two or three categories obtained from the results of a Wilcoxon Rank Sum test for comparing the median volume and spread before and after option introduction, is used. It is found that for the relative volume, individual option introduction has led to a favourable effect in terms of increasing the volume post introduction of options; however index options seem to have had a negative effect. As for the spread, index options seem to have had a stabilizing influence on the underlying stocks than the individual options.