Sector-specific study of factors affecting FII in Indian stock market

Abstract

Indian stock market is a liquidity driven market which has evolved dramatically since the opening ofequity markets through liberalization in September 1992. Foreign Institutional Investors (FIIs) have seena tremendous growth in these markets in past 20 years. In addition to this, the finance world hasundergone renaissance during the Asian crisis, dot com crisis and the sub-prime crisis. All these eventshave emphasized the importance of a fair understanding of expected and unexpected factors impactingthe stock market volumes and liquidity in order to leverage the returns for institutional and individualinvestors. Through our CCS project, we propose to provide this understanding and an overview of theinvestor sentiment based on the primary drivers of the FII flow.Of the 25% floating stock in the Indian Stock Market, foreign institutional investors (FIIs) account forabout 35% of the free float available. This is despite the fact that they invest in just a few highly liquidstocks. The general speculation about foreign institutional investors is that they are looking for shortterm gains on their investments. As a consequence of the same, they use trading strategies like positivefeedback trading and herding (buying/selling stocks together). Through our project we aim to modelsuch behavior including variables such as market volatility and investor sentiment. Such modeling willhelp offset price overreaction which results due to FII behavioral biases.We plan to analyze stock market movement data and track major financial happenings over the pastyears. Based on this, we aim to understand the factors that affect investor sentiment. Our goal is todevelop a feasible trading strategy, especially for institutional investors, which is not greatly affected byherding and positive feedback. This would lead to steadier FII flows as investment decisions would bemade through rational decisions than by ‘animal spirits’.