An Empirical Evidence of Dynamic Interaction between institutional fund flows and Stock Market Returns

This study examines the dynamics of the relationship between institutional investment flow and stock returns for India using daily data over the period of 1st Jan 2002 to 31st July 2012. The analysis has been conducted in a two and three factors vector autoregression framework in which we considered investment flow of two sets of institutional investors i.e., foreign institutional investors (FIIs) and domestic institutional investors (DIIs), separately as well as jointly to form the endogenous part of vector autoregression system. The separate analysis for each institutional investors group reveals that, FIIs flow do not have any significant impact on market returns, the DIIs investment flow do. We also find that the fund flow from both the investor groups significantly affected by their own lags and lagged returns, implying that they follow their own past strategy as well as the recent market behaviour albeit their trading strategy differs. Considering these two institutional investment groups jointly, we find that the net flow of both FIIs and DIIs significantly influences Indian stock market even after controlling for market fundamentals. Further we find a feedback relationship between the institutional investment flow and stock market returns. Overall, it is found that the institutional investment flow collectively impact the stock market returns.