An Empirical Investigation of FIIs Role in the Indian Equity Market : A Firm Level Analysis

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