Impact of FII Investments on Stock Market Volatility and Foreign Exchange Reserves: The Indian Experience

Abstract

Volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. The increased interest of foreign institutional investors (FIIs) in Indian equity market has been correlated frequently with the volatility in stock markets in India. This paper investigates the nature of the causal relationship between Net FII flows, the Stock Price Movements, and Foreign Exchange Reserves (FERs). The unit root test was applied to ascertain stationarity of the time series data and then by applying the Granger Causality Test, the causal relationships using monthly data for the 20 years period was tested. The results show that there is bi-directional Granger Causality between BSE (Bombay Stock Exchange) Sensex and FII Flows. Thus FII Flows are Granger Caused by BSE Sensex and BSE Sensex is Granger Caused by FII Flows. The FERs do Granger Cause BSE Sensex but BSE Sensex does not Granger Cause FERs. There is bi-directional Granger Causality between FERs and FII Flows. Thus FII flows Granger cause FERs and similarly FERs Granger Cause FII Flows.