IMPACT OF FII ON

CAPITAL MARKET
PREFACE
This project, in a way, reveals the dependence of
Indian capital markets on the FIIs investment for
the period starting from January 1993 to
September 2001. I have applied a simple linear
model to estimate the effect of FII on the stock
index. The data analysis tools used in the research
is correlation and regression.
I have taken seven indices to study the impact of
FII on Indian bourses. Two of these indices are
Sensex and Nifty while other five are industry
specific index of BSE. These seven indices give
the close picture of Indian stock exchanges. The
FII s started investing in Indian capital market
from September 1992. I have taken average
monthly data of FIIs and monthly closing index of
all the indices
INTRODUCTION
This research project studies the relationship
between FIIs investment and stock indices. For this
purpose I selected India’s two major indices i.e.
Sensex and S&P CNX Nifty. These two indices, in
a way, represent the picture of India’s stock
markets. I also selected the five industry specific
indices of BSE i.e. BSE CD, BSE CG, BSE
FMCG, BSE HC and BSE IT so as to further
observe the effect of FII on particular industry. So
this project reveals the impact of FII on the Indian
capital market.
There may be many other factors on which a stock
index may depend i.e. Government policies,
budgets, bullion market, inflation, economic and
political condition of the country, FDI, Re./Dollar
exchange rate etc. But for my study I have selected
only one independent variable i.e. FII. This study
uses the concept of correlation and regression to
study the relationship between FII and stock index.
The FII started investing in Indian capital market
from September 1992when the Indian economy
was opened up in the same year. Their investments
include equity only. The sample data of FIIs
investments consists of monthly average from
January 1993 to September 2001 with 105
observations.
Objective: The objective of my research is to find
the relationship between the FIIs investment and
stock index. I have also analyzed the impact of FII
on specific industrial sector indices.
Null Hypothesis (Ho): The various BSE indices
and S&P CNX Nifty index does not rises with the
increase in FIIs investment.
Hypothesis (H): The various BSE indices and
S&P CNX Nifty index rises with the increase in
FIIs investment.
RESEARCH DESIGN
Problem: What is the impact of FIIs investment on
the Indian capital market?
Hypothesis: The various indices of BSE and NSE
Nifty rises with the
increase in FIIs investment.
What to observe?
For my research purpose I selected six indices of
BSE i.e. Sensex, BSE CD, BSE CG, BSE FMCG,
BSE HC and BSE IT and one index of NSE i.e.
S&P CNX Nifty. The sample data of FIIs
investments consists of the monthly average from
January 1993 to September 2001 with 105
observations. The sample data of Nifty and Sensex
consists of the monthly closing index January 1993
to September 2001 with 105 observations while
the past three years data has been taken for other
BSE indices with 33 observations in each case.
How to observe?
The data regarding indices of BSE was taken from
the site of BSE and BSE yearbook 2001. I got the
data on FIIs investment from Reserve Bank of
India’s site. The data of NSE Nifty index was
obtained from the site of national stock exchange.
Other financial sites, newspapers and magazines
helped me in collecting the required data.
How to record observation?
I have taken the monthly closing index of all the
indices. For FIIs I have recorded monthly average
of the net investments made by them in the Indian
capital market.
Net Investments = Purchases – Sales
Model: A simple linear relationship has been
shown between two variables using correlation and
regression as the data analysis tools. One variable
is dependent and the other is independent. I have
taken FII as the independent variable while the
stock index has been taken as dependent variable.
The impact of FII has been separately analyzed
with each of the index. So, correlation and
regression has been separately run between FII and
seven indices taking one index at a time.
Inference: If the hypothesis holds good then we
can infer that FIIs have significant impact on the
Indian capital market. This will help the investors
to decide on their investments in stocks and shares.
If the hypothesis is rejected, or in other words if
the null hypothesis is accepted, then FIIs will have
no significant impact on the Indian bourses.
LITERATURE REVIEW
Some of the literature surveys done for this project
are:
1. Impact of U.S. stock market on Indian stock
markets – by Bala Arshanapalli and Mukund S.
Kulkarni
They examined the nature and extent of linkage
between the U.S. and the Indian stock markets.
The study uses the theory of co-integration to
study interdependence between the BSE, NYSE
and NASDAQ. The sample data consisted of daily
closing prices for the three indices from January
1991 to December 1998 with 2338 observations.
The results were in support of the intuitive
hypothesis that the Indian stock market was not
interrelated to the US stock markets for the entire
sample period. It should be noted that stock
markets of many countries became increasingly
interdependent with the US stock markets during
the same time period. India was late in effecting
the liberalization policy and when it implanted
these policies it did so in a
careful and slow manner. However, as the effect of
economic liberalizations started to take place, the
BSE became more integrated with the NASDAQ
and the NYSE, particularly after 1998. It must be
noted that though BSE stock market is integrated
with US stock markets, it does not influence the
NASDAQ and NYSE markets.
2. Are the structural changes in MF investing,
driving the US stock markets to its current levels –
by Michael Mosebach and Mohammad Najand
(Old Dominion University)
They examined the long run equilibrium relation
between the net flow of funds into equity MF and
the S&P 500 index. Applying the Engel and
Granger correction methodology followed by a
state space procedure, we find that the levels of the
stock market are influenced by the net flow of
funds into equity MFs. Their findings indicate that
the US equity market appears to be rationally
adjusting to a structural change in the behaviour of
the US investing public.
3. On stock return seasonality and conditional
heteroskedasticity – by Kenneth Beller
(Washington State University) and John R.
Nofsinger
(Marquette University)
They modeled the seasonal volatility of stock
returns using GARCH specifications and size-
sorted portfolios. Estimation results indicate that
there are volatility differences between months of
the year and that these seasonal volatility patterns
are conditional on firm size. Additionally, they
found that seasonal volatility does not explain
seasonal returns when the reward for risk is held
constant over the sample period. Specifically, their
results indicate that much of the abnormal return in
January for small firms cannot be entirely
attributed to either higher systematic risk or a
higher risk premium in January.
4.Price pressure and the role of substitutional
investors in closed-end funds –by Richard W.Sias
(Washington State University)
A trader-intensified transactions database is
employed to investigate: (1) the relation between
order-flow imbalance closed-end funds share
prices and discounts (2) the role of institutional
investors in closed-end funds. Empirical results are
consistent with the hypothesis that buyers (sellers)
of closed-end funds face upward (downward)
sloping supply (demand) curves. The results also
demonstrate that ownership statistics fail to
accurately
reflect institutional investors’ importance in
closed-end funds market. The results failed to
provide the evidence that institutional investors
offset the position of individual investors or that
institutional investors face systematic “noise trader
risk”.
5.On the dynamic relation between stock prices
and exchange rates - by Richard A.Ajayi and
Mbodja Mougou (Wayne State University)
In this study they imply recent advances in the
time-series analysis to examine the inter-temporal
relation between stock indices and exchange rates
for a sample of eight advanced economies. An
error correction model (ECM) of two variables
employed to simultaneously estimate short-run and
long-run dynamics of variables. The ECM result
revealed significant short-run and long-run
relationship between two financial markets.
Specifically, the results show that increase in
aggregate stock prices has negative short-run effect
on domestic currency value. In the long-run,
however, stock prices have positive effect on
domestic currency value. On the other hand
currency depreciation has negative short-run and
long-run effects on stock market.
RESEARCH METHODOLOGY
Models:
Regression Analysis: This analysis tool performs
linear regression analysis by using the "least
squares" method to fit a line through a set of
observations. We can analyze how a single
dependent variable is affected by the values of one
or more independent variables — for example,
how an athlete's performance is affected by such
factors as age, height, and weight. We can
apportion shares in the performance measure to
each of these three factors, based on a set of
performance data, and then use the results to
predict the performance of a new, untested athlete.
Correlation: This analysis tool and its formulas
measure the relationship between two data sets that
are scaled to be independent of the unit of
measurement. The population correlation
calculation returns the covariance of two data sets
divided by the product of their standard deviations.
We can
use the Correlation tool to determine whether two
ranges of data move together — that is, whether
large values of one set are associated with large
values of the other (positive correlation), whether
small values of one set are associated with large
values of the other (negative correlation), or
whether values in both sets are unrelated
(correlation near zero).
Data: The sample data consists of 105
observations for FII, Sensex and S&P CNX Nifty
starting from January 1993 to September 2001.
The sample for other five indices of BSE consists
of 33 observations starting from January 1999 to
September 2001. I have taken the monthly closing
index of all the indices and monthly average of net
investments made by FII. The FIIs started
investing in Indian capital market from September
1992. The number of scrips under following index
are:
BSE Sensex – 30
NSE Nifty – 50
BSE Consumer Durables (CD) – 22
BSE Capital Goods (CG) – 49
BSE Fast Moving Consumer Goods (FMCG) – 44
BSE Health Care (HC) – 48
BSE Information Technology (IT) – 42
FII was taken as independent variable. Stock
indices were taken as dependent variable. The data
was taken from various financial sites.
FINDINGS
The findings for Multiple R R2 Standard
the data sample
after applying
correlation and
regression:
Correlation with
FII
NSE Nifty 0.307 0.302 0.0915 221.1
BSE Sensex -0.017 0.017 0.0003 31957
BSE CD -0.011 0.0111 0.0001 379.6
BSE HC 0.003 0.0067 0.0000 301
BSE FMCG -0.047 0.0511 0.0026 130.6
BSE CG -0.017 0.0995 0.0099 233.9
BSE I 0.236 0.2302 0.0523 1392.
Findings for the
period starting
January 1997 to
December1998:
Correlation with
FII
NSE Nifty
BSE Sensex
T