Trading activity of foreign institutional investors and volatility

Abstract

We investigate whether the trading activity of foreign institutional investors (FIIs) adversely affects volatility in the Indian stock markets. Aggregate trading activity of FIIs dampens market volatility whereas aggregate trading activity of domestic investors exacerbates market volatility. Positive shocks in aggregate trading activity have a greater impact than negative shocks; this asymmetry is stronger for aggregate domestic trades. We also relate individual stock volatility to tick-by-tick transaction volume, conditional on trader type and transaction type. Trading among FIIs does not increase stock volatility, but when FIIs sell to domestic clients or when domestic clients trade amongst themselves, volatility increases. + The authors are grateful to the Centre for Analytical Finance (CAF), ISB and Prof. Sankar De for sharing the NSE data and to Bhargav Kali and Sesha Sairam for able research assistance. The responsibility for all the errors and shortcomings rests solely with the authors.