Behavioral Modeling of Foreign Institutional Investor’s in Indian Equity Market

Abstract

In the last decade, the Foreign Institutional Investor (FII) flows have increased almost twenty times and attained shares of thirteen and six percent in the National Stock Exchange and Bombay Stock Exchanges respectively in the cash segment of the Indian equity market. This raises the issue of behavioral modeling of FII flows with respect to local and global stress in the market. The present study empirically documents static and dynamic interaction between FII flows and stock market returns using daily data from 2000 to 2009 using ordinary least squares regression and vector auto regression along with an impulse response function. The regression results show strong evidence of positive feedback trading of FIIs with an adjusted R square of eleven percent. Further a Granger Causality test leads to rejection of both of the null hypotheses lending strong support to a bidirectional relation between FII flows and equity market returns in Indian. However, the overall response function of institutional investors to a one standard error shock reveal a sharp and significant impacts dying out in four to five days. Thus, the paper recommends active and informed churning strategies by portfolio managers and investors dealing with firms with higher FII participation at the time of local or global stress.

Keywords: Positive Feedback, FII, Granger Causality, VAR, Market Return, Impulse

JEL Classification: G11, G15