An Empirical Study on the Dynamic Relationship between Foreign Institutional Investments and Indian Stock Market

Abstract

Foreign investment is very important to strengthen the economy of any country and Foreign Institutional Investments (FII) have gained a significant role in Indian stock markets. This study investigates the dynamic relationships between FII and Indian stock market during 2000 to 2013. The Johansen’s cointegration test results suggest that there exists a long term relationship between FII and stock indices. Further the error correction term of Vector Error Correction Model (VECM) shows a long-run causality moves from Indian stock market to FII but not the vice versa. The Granger Causality test under the VECM framework confirms the same unidirectional causal relationship runs from Indian stock market to FII in short-run. The Variance Decompositions analysis revealed that the Indian stock markets are strongly exogenous in comparison with FII in the sense that shocks to FII explained only a very small portion of the forecast variance error of the market index. Finally from the Impulse Response Functions analysis it was noticed that the responses generated from a positive shock on FII value are initially high but do not persist for a longer period of time. On the other hand the responses of a positive shock generated in stock prices have a persistence and growing effect on the value of FII.