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The IUP Journal of Applied Economics
An Empirical Analysis of the Relationship Between FPI and Nifty Returns
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This study is an attempt to evaluate and analyze the relationship between Foreign Portfolio Investors (FPIs) and the Indian stock market returns. With the stable economy, better growth prospects, liberal government policies and many more profitable opportunities, India has become a hot destination for FPI investments. Thus there is a need to study the impact of these investments on the market returns. Daily data of foreign net investment and Nifty returns, for the period starting from April 2004 to December 2015, has been used for evaluating the presence of feedback trading among the foreign investors. Vector autoregression and Granger causality have been used to test the presence of feedback trading hypothesis and establish the cause and effect relationship among the variables. The results suggest that FPIs are influenced by the Nifty returns but the opposite relationship does not hold. Also it is found that feedback trading is present in the short run with FPI getting influenced even by the Nifty’s last 12 days returns. As the frequency of the data is changed to monthly, the feedback trading hypothesis does not hold true. In other words, it can be said that FPIs’ net investment is positively influenced by Nifty returns.

 
 
 

The study of the behavior and investing pattern of Foreign Portfolio Investors (FPIs) has gained much momentum in the past few decades. The main reason for this surge can be attributed to the growth in the emerging markets which made them an attractive destination for foreign investments. These emerging markets are dependent heavily on foreign investment and thus researchers all over the world are trying to examine the impact of these foreign investments on the developing as well as developed economies.

FPIs play an important role in stock market even though their volume of trade is not much high in comparison to the individual investors or market participants. FPIs are perceived to be information efficient participants and also their assessment about the market movement is considered infallible. Hence, they can be considered as the driving force in determination of market sentiments and price trends prevalent in the Indian market. They only do delivery-based trades, that is why their emergence has been a debatable issue among researchers. Foreign institutional investors’ main objective is to diversify the investments internationally via various strategic business units. This diversification helps them in exploiting the lucrative opportunities in other international markets as well as hedge the risk involved therein.

Worldwide there has been mixed views on the investments from the foreign institutional investors as it has both benefits and uneasiness attached. To second these views, it is often said that FPI flows are like hot money and more volatile as compared to other forms of investment. Moreover, if the investor base is unrestricted, then there are more expected returns in the market as compared to when the base is of restricted investors. With this foreign entry, the investor base has broadened, increasing the diversification and risk-sharing opportunities (Merton, 1987; and Clark and Berko, 1997).

As FPIs have more information about the market so even at the slightest hint of trouble in the host country, they pull back their investments. With these sudden large and concentrated withdrawals, there were instances when the economy faced disastrous consequences. However, there are some economists who have different opinion on these foreign investments. They argue that with the advent of FPIs, markets have become more efficient, transparency of the transactions and dealings has increased, better governance practices have been followed, and markets have become more liquid (Banaji, 2000).

India being one of the fastest emerging economies can be selected as the perfect representative of stock market of the emerging markets. Foreign investors have recognized great profit-making opportunities in India which can be attributed to strong economic scenarios, convenient government policies, and huge growth prospects. FPIs have played the very influential role since their first investment in 1992 in the Indian stock markets. Almost over all these years till now they have been the net investors in our equity markets, except for the crisis period of 1998-1999 and subprime crisis of 2008. FPIs’ net equity investment in Indian stock exchanges touched 29,217 cr during the year 2016. These investments have played a major role in the movement of our stock markets as well as the growth of India. All this collectively is making India the hottest destination for foreign institutional investments.

In this regard, the impact of FPIs has been studied with respect to two theories, i.e., base broadening hypothesis and feedback trading hypothesis. The former theory says that the entry of foreign players as investors in the market expands the existing investor base which in turn increases diversification, thus leading to reduced risk. The latter hypothesis says that FPIs are feedback traders, i.e., they depend on their previous investing pattern and also they enter foreign market only when there are positive signals and move out when they perceive any negative information. According to the base broadening theory, market becomes complete, its information flow increases and also there is no impact on volatility and return increases as the cost of investment is low. On the other hand, feedback trading states that FPIs reap benefits and withdraw from the market which leads to increase in the market volatility.

Thus, these two hypotheses explain both the sides of FPI investment. In order to examine which hypothesis holds true in reality, various studies have been carried out analyzing the impact of FPIs on the stock market. In the present study, an attempt has been made to analyze the impact of FPI on the Nifty returns and also how the Nifty returns are impacting FPI in the short- as well as long-term scenario. Also the study will re-examine the existing studies on the impact of FPIs and analyze the feedback of security prices on the FPIs. The paper is structured as follows: it reviews the existing studies followed by a discussion of the objectives and research methodology. Subsequently, it highlights the findings, followed by the conclusion.

 
 
 

Applied Economics Jouranl, Relationship between Foreign Portfolio Investors (FPIs),Indian stock market returns