An Econometric Analysis to Test the Causal Link between Foreign Institutional Investors and Indian Stock Market

Abstract

Foreign Institutional Investors is one of the very important source of portfolio capital. Earlier, the capital flow was only among the industrialized economy and the flows towards the developing economies was limited. Foreign Institutional Investors have been playing a key role in the Indian Financial Markets since early 1990. This was allowed to make portfolio investment in 1992. This paper intend to investigate the Impact of FII on Stock Market in India by employing the methods of Johansen co-integration test, Error correction model and granger causality test empirically in India. The test result reveals a positive correlation between the variables and a long run relation exist between them is divulged by cointegration test. Further, the Error correction model and granger causality exhibits an independent relation between the variables. The possible reason can be that Portfolio capital flows are consistently short term investment and it is used to analyze a particular stock or the entire stock market. Also, there are many factors that stimulate the stock market movement. Possibly this can be the reason for independent relation between the variables.

Keywords: Foreign Institutional Investors, Indian Stock Market, Johansen Co-Integration Test, Error Correction Model, Granger Causality Test

JEL Classification: C20, C32, E44, F21, F35, G10, G11