Impact of foreign and domestic investment in stock market volatility: empirical evidence from India

Volatility is one of the most important factors of investment decisions. Unexpected information forces the investor to trade abnormally in the market which in turn affects the volatility of the market. But this kind of trading behavior has a different impact on the different market segments. This study investigates the effect of unexpected DII and FPI flows on the volatility of large-cap, mid-cap and, small-cap stocks in Indian markets. Using ARMA (1, 1) and TGARCH (1, 1) model, we estimate the impact of unexpected FPI and DII flows on volatility. The main result of the study shows that unexpected flow of FPIs has a positive impact on market volatility but this impact is reduced by unexpected flow of DIIs. Further, results show that unexpected selling of FPIs increase volatility more than unexpected purchase. Impact of unexpected flow of DIIs flow is more dominating in small-cap stocks. Results from this study are useful for policymakers and regulator.