HOW MUCH DOES VOLATILITY INFLUENCE STOCK MARKET RETURNS? EMPIRICAL EVIDENCE FROM INDIA

This paper investigates the relationship between risks and returns in the Indian stock market, focusing specifically on the volatility anomaly (VA). We consider various risk measures such as variance, beta, relative variance, relative beta, downside beta, downside semi-variance, and value at risk. The paper begins with a theoretical discussion on risk and the selection of risk measures to explain the trend pattern in expected stock returns. Notably, the study emphasises downside risk measures due to the risk-averse nature of institutional investors in India. The empirical analysis is conducted on a cross-section of stocks listed on the National Stock Exchange (NSE) over a 10-year period from July 2010 to June 2020. Daily stock returns are calculated, and the relationship between risk measures and mean returns is examined. The findings suggest that low-risk stocks, characterised by lower volatility and systematic risk, tend to exhibit higher expected returns over the long term. The study further explores the time horizon of this relationship and concludes that the volatility anomaly is more prominent in the medium to long term rather than the short term. Robustness checks are performed, including analysing the data on a rolling-year basis for different time horizons and examining the 6-month period during the COVID-19 pandemic in 2020. Understanding risk-adjusted returns is crucial for modern investors, and this study contributes to the existing literature on the low-risk anomaly. It highlights the advantages of investing in low-volatility stocks, emphasising the compounding effect and the enhanced performance of less volatile stocks over extended time periods. These findings have implications not only for investors in the Indian stock market but also for those in other emerging Asian countries.