This study examines the relationship of FII flows with firm level stock returns in the Indian equity market.
The globalization process and the recent reforms in the Indian financial sector have given the FIIs a strategy
for international diversification of portfolios, and for hedging risk. At the aggregate level, FII investments and
NSE Nifty seem to have a strong unidirectional causality with some weak evidence of bi-directional causality.
The authors conducted a Granger causality test to check the direction of causality at the firm level, and
Garch(1,1) for volatility and spillover effect. The study has been conducted on 36 listed firms during the period
from August 2002 to August 2004. The results show the existence of bi-directional causality between stock
returns and FII flows and vice-versa in 13 firms, and uni-directional causality running from stock returns to
FII flows in 21 firms. The role of FIIs becomes important in influencing equity returns at the firm level,
especially in the government-owned companies. It seems that FIIs are value investing in anticipation of further
reforms that is driving up the equity returns. There is volatility clustering in individual series but no
transmission from one to another, except for one key company. Therefore, there is very little destabilizing effect
of FII flows on individual equity returns of the firms during the period of study.
The process of globalization and liberalization has given the foreign portfolio managers
a strategy for international diversification of portfolios and for hedging risk. International
diversification is a strategy for achieving a better risk-return trade-off. The inflow of
foreign capital, in search of a better risk-return trade-off, helps the home country to share
risks with foreign investors. Foreign investment inflow could also flow out with change
in the perception of risk to investment in the home country. The change in perception
may be influenced by less favorable investor’s expectations to future economic activity,
changes in real interest rates or currency risk. Foreign Institutional Investors (FIIs)
outflows have often been blamed for the collapse of stock markets (Dornbusch and Park,
1995; Radelet and Sachs, 1998) and having a destabilizing effect on local stock prices. The
reversals in the stock market and the currency crises of East Asia in the 1990s are
important lessons for the emerging markets (Corsetti, 1998; UN, 1998). |
