BEHAVIOUR OF INDIAN STOCK MARKET-EVIDENCE AND EXPLANATION Naliniprava Tripathy, Indian Institute of Management, Shillong, India K. N.

Badani, Indian Institute of Management, Shillong, India ABSTRACT This study investigates the relationship between FII investments and the Indian stock market performance during November 2003 and January 2007 by using forecasting ARIMA model. The study shows that past FII investment have significant impacts on current BSE Sensex & NSE Index; but there is no significant impact of current FII investment on current BSE Sensex & NSE Index. An important implication of these findings is that the FII investments in India deserve a well- calibrated policy response while the daily movement of stock market in India should be better explained by other factors than FIIs. Keywords: BSE Sensex, NSE Index, FII Investment, ARIMA Model

1. INTRODUCTION The emerging economies have been witnessing an unprecedented surge in capital inflows. The last three years in India have witnessed virtual bull-run in terms of rising inflow of investments from the FIIs. The numbers of registered FIIs have also shown an increasing trend..This huge increase in the number of FIIs shows their continuing interest in investing in Indian stock market. The financial theory is that FII investments broadens the base of portfolio diversification and cause a long-term increase in the stock prices by reducing the equilibrium rate of return. It was however found that the FII behaviour played a significant role during East Asian Crisis. So understanding the relationship between FII investment and Indian Stock Market is very important as it may have important policy implications. Warther(1995) in his ‘price pressure hypothesis’ suggests that the increase in share prices associated with foreign investment flow is caused by temporary liquidity (i.e. excess demand) and predicts that this change in share price is subsequently reversed. Merton (1997) shows that the expected return in the market with unrestricted investor base is higher than restricted investor base. Entry of foreign investors in the stock market broadens the investors’ base, which increases diversification and risk sharing, lowering the risk premium for country specific volatility. Agarwal (1997) Chakrabarti (2001) and Trivedi and Nair (2003) found that the equity return has a significant and positive impact on the FII. But, given the huge volume of investments, foreign investors could play a role of market makers and book their profits i.e. they can buy their financial assets when the price are declining, thereby jackingup the assets price and sell when the assets price are increasing .Rai and Bhanumurty (2003) studied the determinants of foreign institutional investment in India during the period 1994-2002, by using monthly data and found that the equity returns is the main driving force for FII investment and is significant at all levels. Gordon and Gupta (2003) also examined causation running from FII inflows to return in BSE and conclude that FIIs act as market makers and book profits by investing when prices are low and selling when they are high. Keeping in view, the present study attempts to examine the relationship between FII investment and the Indian stock market performance. It aims to investigate whether average monthly BSE Sensex and NSE Index are dependent on the current and past FII net inflows. It also seeks to assess whether FII net inflows are dependent on the current and past market BSE Sensex & NSE Index.

2. DATA SOURCES &METHODOLOGY For the purposes of this study, monthly net FII investment data and monthly average BSE Sensex and NSE Index have been used. The FII investment monthly data have been collected from November 2003

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Q statistics is often issued. The data for BSE sensex and NSE index have been taken from the website of Bombay Stock Exchange. Rather it makes use of the information in the series itself to generate forecasts. if there is no serial correlation. Analysis of ACF and PACFs is important because correlograms for stationary JOURNAL OF INTERNATIONAL FINANCE AND ECONOMICS. Volume 9. If there is negative correlation the statistics will lie somewhat in between 2 and 4. the BoxJenkins methodology comes into picture . and one month. Hence it can be conclude that the error terms in each of the models are not serially correlated. The correlogram test is done with Autocorrelation Function and Partial Autocorrelation Function. The study uses the d-statistics. In order to determine whether a series follow a purely auto regressive process or purely a moving average process. It is evident from all the tables that the Durbin Watson `d’ statistics for all the models are around 2. Number 5. It relies heavily on auto correlation patterns of the data. U t  a  P1U t  1  P 2U t  2           P p U t  p   t  1 6  1   2  t  2           q  t  q ARMA model use combinations of past values and past errors and offer a potential for fitting models that could not be adequately fitted by using an AR or MA model separately when the time series have to be differenced to make it stationary. It is clear from the Table-2 that past FII investment have quite impact on current BSE sensex & NSE index. ARIMA Model: The Acronym ARIMA stands for “Auto Regressive – Integrated Moving Average” which is a class of linear models capable of representing stationary as well as non-stationary time series. AR (P) has the form: U t  P1U t  1  P 2 U t  2           P p U t  p   t Where Ut is the time series and t is an uncorrelated random error term with zero mean and constant variance. A moving average forecasting model uses lagged values of the forecast error to improve the current forecast. as a test of weather the series is white noise.ARIMA (Auto Regressive Integrated Moving Average) models are generalizations of the simple AR model that use three tools for modeling the serial correlation in the disturbance. Before any regression analysis can be applied to time series data. The `t’ value of these variables is not significant. it is essential to find that these data are random or the error terms are free from auto correlation. RESULTS AND DISCUSSION The regression Model attempts to find whether currents months’ Net FII investment is dependent on current and past BSE Sensex and on current and past NSE Index. the DW statistics will be around 2.to January 2007 from the SEBI Bulletin. Now it is essential to find out that whether these results are in conformity to the ARIMA findings.month lag and three. the model is called ARIMA instead of ARMA. The Table 1 shows that the one month lag value. The first tool is the auto regressive or AR term. An MA (q) has the form: U t  a  1 t  1   2  t  2            q where a is constant The auto regressive and moving average specifications can be combined to form an ARMA (p. An autoregressive model of order P. It does not involve independent variables in its constructions. The regression model also examines whether current month’s BSE sensex & NSE index is caused by present and past FII investments. 3. It is also found from the analysis that one-month lag and two-month lag values of BSE&NSE sensex significantly affect current BSE sensex at 1% and 5% level of significance. q) specification. The DW statistics will fall below 2 if there is positive serial correlation. Methodology: The multiple regression analysis has been used in the study. For the formal test of significance.month lag values of BSE Sense& NSE index. The most popular test to ascertain the presence or absence of auto correlated error terms is the Durbin Watson d-statistics. and RBI website for a period of 3 years. 2009 125 . two. two month lag value of net FII do not significantly affects the current months investment pattern of FIIs.

942 1.147 .857 3. NSE index and FII investment are presented in the Table 3 through Table 5. 0) on the AIC value is 59.873 2493. since the AIC value of –94.284 1.071 .158 1.429 . The Table 11 shows the summary results of ARIMA model.100 . Table-11 indicate that FII also follows autoregressive process of order 1 and moving average process of order 0 and 1 respectively when regressed on BSE and NSE index as given by the minimization of AIC values.269 . 0.0.318 3.771 14.057 .B Stand ardised  T Multiple R 2 R Adj.103 FIIt-2 . This indicates that current BSE sensex depends on the just preceding months’ BSE sensex as well as on FII investment. 0.087 3.917 10.688 JOURNAL OF INTERNATIONAL FINANCE AND ECONOMICS.170 1. The Table 10 reveals that the ARIMA (1.process exhibit certain characteristic patterns.873 2539.013 . 0) when regressed on FII investments.E. Number 5.439 is closest to zero.249  1656. 0).504 NSE t 1.919 -2.399 -.664 . 2009 126 .100 -.715 13. An important implication of these findings is that the FII investments in India deserve a well. R2 DW F BSEt -. After differencing once.9 41 1. 0. These results also reinforce the findings of regression models 1and 2. Table 3 and Table 4 indicate that there is very high auto correlation between current and past BSE sensex as well as NSE market index. The reliability of the ACFs and PACFs can also be checked through the findings of various ARIMA model.283 . The AIC in Table 8 indicates that BSE sensex follows the ARIMA (1.291 . which is confirmed with our multiple regression analysis. The study shows that past FII investment makes significant impact on current BSE Sensex & NSE Index.190 . 0) in the AIC value’s 59.340 4.346 8.144 -. The Table 8 and Table 9 showed the presence of mixed ARMA process. but there is no significant impact of current FII investment on current BSE Sensex & NSE Index.914 which is minimum and Table 11 depicts ARIMA (1.260 NSE t1 NSE t2 NSE t-3 FI It1 FI It2  1656.228 .calibrated policy response while the daily movement of stock market in India should be better explained by other factors than FIIs.060 . 0. The auto correlation of the series of BSE sensex.777 15.995 .970 .525 .368 . Similarly the Table 10 and Table 11 after log transformation indicated mixed ARMA process.521 .412 . The immediate next minimum AIC is for ARIMA (2.839 .002 1.091 .221 . 0) when regressed on Net FII investment since the AIC value of –94.649 . 4. CONCLUSION The present study examined the impact of Net FII investment on the Indian stock market represented by BSE sensex and NSE index.636 -.422 are closest to zero. Table 7.922 BSEt1 BSEt2 BSEt3 FIIt-1 . the ACF and PACF for BSE sensex and NSE index show that the series have become stationary which is depicted in the Table 6.366 . Table 1: Regression Analysis of Net FII Investment on Current and Past BSE Sensex. If correlogram of a time series exhibits such a pattern. But ARIMA output shows a warning that the order of the process may not be correctly estimated. Volume 9.117 .093 . Table 4 and Table 5 shows that BSE sensex and NSE index series is non-stationary and differencing and log transformation is needed to make the series stationary. This result is also confirmed by regression results. The Table 11 reveals that NSE index follow the ARIMA (1.184 . the ACFs and PACFs however will be around zero.115 .100 .419 is minimum. For stationary process.204 2. These findings are also in conformity with the regression results of significant (at 1% level) impact of past BSE Sensex and NSE Index on present BSE Sensex and NSE Index respectively. the data series is stationary.099 2. The Table 5 reveals that the FII series is stationary and requires no differencing.979 11.366 5.07 . NSE Index and Past Net FII Investments Predictor Variable Unstand ardised B Unstan dardised S.26 2.

603 0.049** 1.000 0.001 -.559 96.000 JOURNAL OF INTERNATIONAL FINANCE AND ECONOMICS.304 Multiple .948 92.989 0.505 84. Number 5.145 .987 51.627 99.968 93.310 -.188 97.536 B Unstan dardised .010 .071 95.012 .000 0.142 0.902 98.153 0.121 Box-Ljung 29.016 -.0.139 0.348 97.142 . Current and Past Net FII Investments Predictor FII t FII t-1 FII t-2 FII t-3 BSE t-1 BSE t-2 FII t FII t-1 FII t-2 FII t-3 NSEt-1 NSEt-2   Variable Unstand ardised .026 1.137 .000 0.669 Prob.001 -.003 .069 1.158 .311 0.205 0.403 0.118 .132 .181 -2.010 .054 .460 95.111 0.995 0.101 0.161 .153 .385 0.024 -0.139 0.68 Standard Error 0.158 0.149 0.607 97.151 .989 R 2 R .000 0.114 0. NSE Sensex and Past BSE Sensex.269 0.Table 2: Regression Analysis of Net FII Investment on Current BSE Sensex.979 Adj R2 .139 .000 0.144 .560* 1. Past NSE Index.340 -.035 -. Volume 9.875 1.122 0.000 0.147 0.840 F 405.000 0.156 0.042 95.292 .251 0.011 -.000 0.B Stand ardised .156 46.345  t . 0.000 0.134 .049 .000 0.299 172. 031 -0.009 1.149 .601 0.719 0.351 -. 0.726 298.000 0.502* 1.164 0.157 0.000 Table 4: Auto Correlation: NSE Index Lag 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Auto Correlation 0.860 0.000 0.000 0.987 0.126 0.736* 8.054 * Significant 1% level * * Significant at 5% level Table 3: Auto Correlation: BSE Sensex Lag 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Auto Correlation 0.134 0.573 99.000 0.075 Standard Error .865 0.332 0.147 .336 97.822 89.974 DW 1.484 0.E.140 .134 0.129 0.734 77.098 0.129 .019 .000 0.156 .334 .077 0.278 66.000 0.491 76.635 99.000 0.144 0.126 0.000 0.036 -.898 96.003 -.191 0.010 .183* 1.000 0.377 -2.121 Box-Ljung 29.414 S.132 0.151 0.138 -5.000 0.000 0.004 .000 0.000 0.137 .142 66.496 0.679 51. 2009 127 .740 83.004 .671 100.870* -2.722 0.0.000 0.000 0.406 -5.915 90.771 94.721* 8.059 1.000 0.319 60.000 0.144* -2.000 0.000 0.123 0.288 -.409 87.137 0.217 99.058 Prob.123 0.013 .000 0.003 .005 -.005 .940 97.

151 0.121 Box-Ljung 4.137 0.148 0.378 Prob.105 0.0.113 0.135 0.146 0.113 0.846 Table 6: Auto Correlation: BSE Sensex Transformations: Log transformation and differencing (1) Lag 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Auto Correlation 0.597 Prob.144 .134 0.142 0.058 0.160 0.876 0.147 0.944 16.0.818 0.0.143 0.140 0.552 17.091 .712 12.516 18. 0.015 .053 0.519 20.252 .017 0.612 6.051 0.564 5.0.084 15.042 0.201 0.656 18.476 16.711 18.465 0.132 0.035 0.052 0.146 0.0.035 11.624 0.Table 5: Auto Correlation: FII investment Lag 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Auto Correlation 0.102 .534 2. Volume 9.0.0.035 0.158 0.789 0.045 0.127 0.132 0.0.124 0.112 Standard Error 0. 0.109 0.011 .0.749 2.139 0.323 7.130 0.151 0.704 0.963 5.151 0.058 .123 0.074 Standard Error 0.133 18.091 15.0.703 19.157 0.229 0.416 6.335 0.181 .121 Box-Ljung 3.081 0.144 0.090 0.153 0. Number 5.298 5.023 0.226 20.060 0.129 0.317 .102 .567 0.601 0.067 0.0.688 8.153 0.029 .0.148 0.0.075 18.944 3.566 0.155 .0.158 0.117 0.138 0.195 JOURNAL OF INTERNATIONAL FINANCE AND ECONOMICS.062 0.153 0.124 18.149 0.831 0.0.651 16.030 0.0.340 19.156 0.029 0.990 Prob.036 0.039 0.155 0.121 Box-Ljung 0.0.509 5.138 0.002 .232 0.406 8.090 .0.351 .163 0.424 0.0.0.124 0.104 .540 11.381 6.112 .011 0.489 5.162 0.389 7.129 0.121 .143 0.082 0.126 0.033 0.880 0.239 10.301 17.0.093 .0.333 19.002 0.146 0.135 0.300 0.129 Standard Error 0.289 .0.982 12.0.269 Table7: Auto Correlation: NSE Index Log Transformation and Difference (1) Lag 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Auto Correlation 0.124 18.0.054 .0.795 2.153 0.0.0.865 0.158 0.060 0.133 .043 0.140 0.115 .130 0.016 0.881 0.033 .256 0.124 .155 0.127 0.160 0. 0.093 0. 2009 128 .963 7.058 .061 0.139 .501 5.054 .253 0.882 4.220 0.118 0.132 0.148 9.811 18.

4 2. 4 2. 3 2.641 0.617 64. 0. 1.i63 -104. 0 Standard Error 0. d.0 2. 0.9 1. 0. 0 2. 0.9 1. 2 1. q) ModelsFor NSE Index Regressed on FII ARIMA (P.39 -113.047 0.1. 5 SE 0. 0.046 0. 1.649 0.5 Standard Error 0.1.566 0.233 Table 9: Summary of ARIMA (p. 3 1.635 0. 1.053 0.631 0.1.00 -116. 7 1.419 61.604 AIC 59.046 0. 1. 1 1.593 0.043 0. 0. 0. 2 1. q) 1. q) 1. 0. 1. 1.041 AIC -94. 0.1. 0 1.941 -108.1.042 0.603 -114. 1.043 0. 0.832 69. 1.740 -115. d.5 SE 0. 0. 0.1. 5 2. 1.573 0.793 -112. 5 2.045 0.228 -101. 3 1.429 -102. d. Volume 9.102. d. 0 1. 1. 4 2. 2 1.0.603 -108.569 0.205 64.679 -108. 1.736 -115.954 -107. 0.824 -104. q) Models For Net FII Investment Regressed on NSE Index ARIMA (p.862 68.044 0.049 0.612 0. 1.043 0.2 2. 1.633 0.599 0.046 0.0145 0.044 0.722 -107.048 0. 0.583 0.577 0. 1. 0.0 2. q) ModelsFor Net FII Investment Regression BSE Sensex ARIMA (P. 0. d. 4 1. 0 2. 1.276 -117.740 69. 7 2.648 61. q) 2.041 AIC -111.060 0. 0.042 AIC -107. 0. q) 1. 1 2.618 0. 0. 7 1. 0.046 0. 7 1.242 64.568 -109. 1 1.045 0. d. 0.046 0. 1.722 -105. d.722 -105.439 -101. 6 Standard Error 0. 2 Standard Error 0.794 -118.598 0. 0. 0.662 -98.7 1.537 Table 11: Summary of ARIMA (p. 1. 2 2.109 ARIMA (p. 1.8 2.828 ARIMA (p. 0. 0.0. 9 2. 4 1.603 0. 5 1.9 2.193 63. 3 2.513 JOURNAL OF INTERNATIONAL FINANCE AND ECONOMICS.0 1.044 0.2 2.667 AIC 63. 1. 1.901 -112.464 64.039 AIC -94.0 2. d.567 63.714 -108. d.044 0.659 -116.0.460 -116. 1.039 0.Table 8: Summary of ARIMA (p.043 0.9 2.0.204 -103.020 0.047 0. 2 2. 1.587 71.854 -118.1.045 0. 0. 1.571 67.914 61.963 -115.606 0.0.677 64. 0 2. d.748 63. 0.045 0.9 1.945 -106.422 -104. 2 1.846 -172. 5 1. d.644 0.603 0. 1 1.568 0. 5 1.045 0.4 2.043 0. 4 1. 2 2. 1. 4 1.285 63.0 1.709 65. 2 1.798 63.046 0.620 0. q) 1. 0.052 0.711 64. 0 1.760 73.662 AIC 59. 5 1. 3 SE 0. 0. 0 1. 0.390 67. 0. 0.048 0. 0 2.604 0. 2 1.707 66.108 -110. 4 1.052 61. 7 SE 0. 1 1. 0 1. 1.054 0.045 0. 1 2.605 ARIMA (P. 0.448 -104.592 0. 2009 129 .759 68.0.373 64. 1 2. d. 5 2. 4 1.282 -108.771 -94.046 0.518 -113.740 68.879 Table 10: Summary of ARIMA (p.666 .052 0. 3 1. q) 1.609 0. 0.061 0.901 ARIMA (P.039 0. 0.644 0.047 0.048 0.5 2. 1 1.514 -110.616 0. 0.599 0. q) 1. 1. 1. 1 1.046 0. 1.046 0.117 -107. 0.649 0. 5 2. Number 5.574 62. 0.046 0.611 0.351 -104. 0. 0 2.043 0.384 -107.672 0.044 0.307 65. 6 1.2 2. 0. 3 1. q) 1.790 72. 0. 0 1.249 -113.192 -114. q) Models For BSE Sensex Regressed on FII ARIMA (p.682 -111. 0.677 AIC 68.

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