Institutional Trading Strategies and Contagion around the Financial Crisis

Abstract

We examine the impact of the recent financial crisis on institutional trading strategies in the Indian equity markets. We find that foreign institutional investors (FIIs) act as short-term momentum traders or positive feedback traders who demand liquidity. Domestic institutional investors (DIIs) act as liquidity suppliers. Both FII and DII order flow exhibit strong persistence and are negatively related. During the crisis period, FIIs are net sellers and reduce their reliance on positive feedback trading strategies but DIIs absorb this increase in liquidity demand by acting as contrarian traders. We also find that, during the crisis period, FII trading provides an additional channel to transmit contrarian (good) news from the U.S. markets to the Indian equity markets.

Keywords: Foreign Investors, Emerging Markets, Momentum, Feedback Trading, Crisis, Contagion