Foreign Institutional Investment Flows and Indian Stock Market Returns: A Cause and Effect Relationship Study

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Foreign Institutional Investment Flows and Indian Stock Market Returns – A Cause and Effect Relationship Study

DR. TANUPA Senior Department University

By CHAKRABORTY Lecturer Of Commerce Of Calcutta

ADDRESS: FLAT NO. – 12 23, CENTRAL ROAD JADAVPUR KOLKATA – 700 032 INDIA

PHONE: (R) 2412-4973 (M) 9830175653 E-MAIL: tanupachakraborty@gmail.com tanupa_cu@hotmail.com

Acknowledgement This research paper is originally published in ‘Indian Accounting Review’, Vol. 11, No. 1, June 2007, pp. 35-48.

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Foreign Institutional Investment Flows and Indian Stock Market Returns – A Cause and Effect Relationship Study Abstract Foreign Institutional Investment (FII) flows, i.e., capital flows across national borders, to emerging market economies (EMEs) have risen sharply over the past one and half decade due to globalization and India is no exception in this regard. However, there is a lot of apprehension regarding the volatile nature of such flows thereby raising questions about the need to encourage FII flows in a narrow and shallow stock market like that of India. There are conflicting theories on the issue of whether FII flows affect or are affected by domestic stock market returns. So, the present empirical study has been undertaken to throw some light on the direction of causality between FII flows and Indian stock market returns using data on both the variables from over the period April 1997-March 2005.

I.

INTRODUCTION

International portfolio flows, as are commonly known as Foreign Institutional Investment (FII) flows, refer to capital flows made by individual and institutional investors across national borders with a view to creating an internationally diversified portfolio. Unlike Foreign Direct Investment (FDI) flows which refer to that category of international investment aimed at obtaining a lasting interest by a resident entity in one economy in an enterprise resident in another economy by way of exercising significant control over its management, FII flows are not directed at acquiring management control over foreign companies. FII flows were almost non-existent until 1980s. Global capital flows were primarily characterized by syndicated bank loans in 1970s followed by FDI flows in 1980s. But a strong trend towards globalization leading to widespread liberalization and implementation of financial market reforms in many countries of the world had actually set the pace for FII flows during 1990s. According to Bekaert and Harvey (2000), FII investment as a proportion of a developing country's GDP increases substantially with liberalization as such integration of domestic financial markets with the global markets permits free flow of pdfMachine - is a pdf writer that produces quality PDF files with ease! Get yours now! 2 “Thank you very much! I can use Acrobat Distiller or the Acrobat PDFWriter but I consider your product a lot easier to use and much preferable to Adobe's" A.Sarras - USA

capital from 'capital-rich' to 'capital-scarce' countries in pursuit of higher rate of return and increased productivity and efficiency of capital at global level. Diversifying internationally i.e., holding a well-diversified portfolio of securities from around the world in proportion to market capitalizations, irrespective of the investor's country of residence, has long been advocated as the means to reduce overall portfolio risk and maximize risk-adjusted returns by the classical capital asset pricing model (CAPM). But a persistent 'home bias' (i.e., the tendency to hold a greater proportion of stocks from the home country vis-a-vis the foreign country) was noticed in the portfolios of investors in capital-rich industrialized countries in early 1990s. With more...
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