Foreign fund flows and stock returns: Evidence from India

We study the impact of foreign institutional investor (FII) flows on stock returns in India. We exploit stock-level daily trading data for FII purchases and FII sales to separate stocks into those experiencing abnormally high and low FII flow innovations. We find that stocks with high innovations are associated with a coincident price increase that is permanent, whereas stocks with low innovations are associated with a coincident price decline that is in part transient, reversing itself within one week. The differential abnormal return between high and low innovation stocks is nevertheless significant, both statistically and economically (relative to stock return volatility), largely unrelated to firm characteristics and increasing during periods of market stress. Our findings are robust in out-of-sample tests. The results are consistent with price “pressure” on stock returns induced by FII sales, as well as information being revealed through FII purchases and FII sales.

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