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Impact of Foreign Investments on Stock Market Volatility: An Evidence from

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 IMPACT OF FOREIGN INVESTMENTS ON STOCK
MARKET VOLATILITY: AN EVIDENCE FROM
INDIAN STOCK MARKET
SHAVETA GUPTA*, NEHA KALRA* AND RAJESH BAGGA**
ABSTRACT
The liberalization and globalization has revolutionized the Indian economy by permitted investments from abroad either in the form of
direct investment in an Indian company or investment by foreign investors in the capital market. Increased foreign inflows have a huge
bearing on the fluctuations caused in the stock market. Using Correlation and Multiple Regression Methodologies, this paper
examines the impact of Foreign Investment inflows on the Indian stock market. The paper finds long-run relationship between Foreign
investment and stock exchange barometer index Sensex by extracting the data on monthly basis, for both the Sensex and the FDI and
FPI from January 2001 to February 2012.Using Regression Model, it was found that increase in FDI significantly influence the
fluctuations in the stock market in India, in tandem with the results of similar studies examined in the literature.
Keywords: Foreign investment, FDI, FPI, Sensex, Correlation analysis and Multiple Regression methodology

INTRODUCTION production process of another country. After the

One of the outstanding features of globalization in
the financial services industry is the increased access
provided to non-local investors in several major stock
markets of the world. Increasingly, stock markets from
emerging markets permit institutional investors to trade
in their domestic markets. This opening up of capital
markets in emerging market countries has been
perceived as beneficial by some researchers while others
are concerned about possible adverse consequences
such as contagion (Ananthanarayanan et al., nd). The
significant economic growth during the past two
decades in most of the developing countries had been
stimulated by foreign capital flows. The post 1990s
period witnessed sharp increase in flows of foreign
capital. Most of the developing countries opened their
capital markets to foreign investors either because of
inflationary pressures, widening current account deficits,
and exchange depreciation; increase in foreign debt or
as a result of economic policy (Bansal and Pasricha,
2009). Now days, a significant portion of Indian
corporate sector’s portfolio is held by Foreign
Institutional Investors who are often viewed as well
informed and better equipped to process information
than individual investors (Han and Wang, 2004). The
opening up of the borders for capital movement these
investments have grown in leaps and bounds. But it
had varied effects across the countries. In developing
countries there was a great need of foreign capital,
not only to increase their productivity of labour but
also helps to build the foreign exchange reserves to
meet the trade deficit. Foreign investment provides a
channel through which these countries can have
access to foreign capital. It can come in two forms:
Foreign Direct Investment (FDI) and Foreign Portfolio
Investment (FPI). While the former results in creation
of physical infrastructure, the later is invested in
financial markets.
Foreign investment (FI) has long been a
controversial issue for the beneficial and adverse
effects. Two main aspects are concerned when it
comes to FI, destabilization and demonstration effects.
Destabilization effect deals with the issue that whether
FI increases or decreases the volatility of stock prices
while demonstration effect indicates whether the
fundamental factors on stock markets would change
(Kit and Yi, 2006). The recent global financial crisis
has revived the need to place some restrictions on
capital flows. Even the IMF, a staunch votary of capital
EFFECTIVE MANAGEMENT

policymakers have become increasingly concerned
about the factors determining foreign investment, the
performance of foreign capital investments, and the
impact of foreign investment on local turnover and on
the volatility of stock prices (Tesar and Werner, 1995).
Foreign Investment refers to investments made
by residents of a country in financial assets and
account convertibility, has acknowledged that capital
controls are a legitimate part of the toolkit to manage
capital inflows in certain circumstance (Ostry, 2010).
Thus, FDI is preferred over FPI because the former is
seen to be stable and, being a bundle of assets in
addition to capital, it could enable the host economy
to gain competitiveness. Portfolio flows are rendering

* Assistant Professors, Apeejay Institute of Management Technical Campus, Jalandhar

** Professor & Director, Apeejay Institute of Management Technical Campus, Jalandhar 1
 the financial markets more volatile through increased
linkage between the domestic and foreign financial
markets (Kohli, 2001, 2003, and Sethi and Patnaik,
nd).The impact of FPIs flows on domestic stock market
is important from governmental as well as investors’
point of view, for example, does the opening up of
the market for FPI increase speculation in the market
and thus make the market more volatile and more
vulnerable to foreign shocks (Li, 2002). FPIs outflows
have often been blamed for the collapse of stock
markets (Dornbusch and Park, 1995, Radelet and
Sachs, 1998 and Khan et al., 2010) and for having a
destabilizing effect on local stock prices.
International capital flows have significant
potential benefits for economies around the world.
Countries with sound macroeconomic policies and
well-functioning institutions are in the best position
to reap the benefits of capital flows and minimize
the risks (Sethi and Patnaik, nd). The potential benefits
of opening domestic markets to foreign investors
cannot be overlooked, however. A major benefit is
the opportunity to attract foreign capital. Infusion of
foreign capital enhances economic growth (Boyd and
Smith, 1996, Levine and Zervos, 1996). Chari and
Henry (2002) used a unique data set of daily returns
of Indian banks. They provided evidence of
significantly positive valuation effect associated with
liberalization of foreign direct investment rules.
The Government of India in 1991 embarked on
liberalizations and economic reforms with a view to
bringing about rapid and substantial economic
growth and move towards globalization of the
economy. As a part of the reforms process, the
Government under its New Industrial Policy
revamped its foreign investment policy recognizing
the growing importance of foreign direct investment
as an instrument of technology transfer, augmentation
of foreign exchange reserves and globalization of
the Indian economy. Simultaneously, the
Government, for the first time, permitted portfolio
investments from abroad by foreign institutional
EFFECTIVE MANAGEMENT
investors in the Indian capital market. India opened
her doors to foreign institutional investors in
September, 1992. During 1991 to 1996 there was a
spectacular rise in net capital flows from industrial
countries to developing countries and transition
economies. This development was associated with
greatly increased interest by international asset
holders in the emerging market economies to find
trend toward the globalization of financial markets
2 (Singh, 1998, and Sethi & Patnaik, nd).
Beginning 1996-97, the group was expanded to
include registered university funds, endowment,
foundations, charitable trusts and charitable. Since
then, FPI flows which form a part of foreign portfolio
investments have been steadily growing in
importance in India (Ananthanarayanan et al., nd).
Initially, the holdings of a single FPI and of all FPIs,
NRIs (Non-Resident Indians) and OCBs (Overseas
Corporate Bodies) in any company were subject to a
limit of 5% and 24% of the company’s total issued
capital respectively. From November 1996, FPIs were
allowed to make 100% investment in debt securities
subject to specific approval from SEBI as a separate
category of FPIs or sub-accounts as 100% debt funds
(Sharma, nd). In 2000, 40% became the ceiling on
aggregate FPI portfolio investment in March 2000.
This was subsequently raised to 49% on March8,
2001 and to the specific sectoral cap in September
2001 (Sharma, nd). According to the latest data
released by Department of Industrial Policy and
Promotion (DIPP), January 2010 witnessed inflows
of US$ 2,042 million as compared to US$ 1,542
million in the month of December 2009.
Talking about FDI inflows in India an increase has
been witnessed over the past few years due to the efforts
of the Indian government. FDI has enabled India to
achieve a certain degree of financial stability, growth
and development and address various problems that
challenge the country. The FDI flows registered a
dramatic increase in 2007-08, from $23 billion to $35
billion, hovered around $38 billion during 2008-10 and
then fell to a lower but still respectable $27 billion in
2010-11. The following figure depicts the recent foreign
investment flows in India.
Figure1: Foreign Investment Flows in India
Source: Chandrasekhar C. P. (2011), Reading FDI trends,
available at http://www.thehindu.com/opinion/columns/
Chandrasekhar/article2141320.ece
 REVIEW OF LITERATURE
Believers of liberalization in foreign investment
flow policy argue that it tends to increase the liquidity
and the efficiency of local markets. They claim that,
in the long run, the expected return decreases as a
result of market integration. Henry (2000), Bekaert
and Harvey (2002), and Kim and Singal (2000)
addressed this issue and tested the abnormal returns
after market liberalization (Adabag and Ornelas, nd).
However, the findings of numerous studies represent
cases where foreign investment has not been
beneficial for a country. There is a growing consensus
among economists that empirical results do not
support the beneficial role of foreign investment. A
rich literature house is available on effect on foreign
flows on the performance of domestic stock market
have been carried out, however, still the world is sans
any consensus on same. In words of Rodrik (1998):
“…persuasive evidence on the benefits of
opening up to capital flows—especially of the
portfolio and short-term kind—has yet to be
provided”.
De Long et al. (1990) studied the possible effects
of positive feedback trading in a theoretical model.
According to the researchers, in the presence of
feedback trading, even rational speculators might
“jump on the bandwagon”, and therefore prices may
go further away from fundamentals. According to
Dornbusch and Park (1995), foreign investors pursue
a positive feedback strategy, which makes stocks to
overreact to change in fundamentals. An attempt by
Clark and Berko (1996) using Warther (1995)
approach to evaluate price pressure by foreign
investors in the Mexican stock market, emphasized
the beneficial effects of allowing foreigners to trade
in stock markets. The study concluded that FPIs are
considered as positive feedback trader means they
buy when the market increases and sell when the
market falls. A research by Bohn and Tesar (1996)
and Brennan and Cao (1997) based on quarterly data
of US investments on foreign equity markets found
a positive correlation of these flows and local returns
on majority of the sample countries.
In order to investigate whether FDI
announcements provide information to investors,
Ding & Sun (1997) studied whether shareholder
benefits were a product of their firms’ FDI decisions,
and whether abnormal returns were attainable by
trading shares. Their results showed that an average
2.73% additional return could be observed by
investors buying and holding the stock of an
announcing firm 21 days around the announcement
date. On the same lines, Wang and Shen (1999) put
forth that large and sudden inflows may stimulate
stock prices while the outflow of FI may reduce
equity value, thus, ultimately, increasing the volatility
of stock markets. In another related study by Bekaert
and Harvey (2000), it was found that insignificant
increase in the volatility of stock returns follow capital
market liberalizations.
Henry (2000), Bekaert and Harvey (2002), and
Kim and Singal (2000) tested the abnormal returns
after liberalization. These studies argued that, with
more foreign investors, start-up companies as well
as existing companies can raise capital easier.
Contrary to the foreign direct investment, foreign
portfolio investors ask for faster returns of their
investment. And this may lead these investors to
suddenly enter or leave a country. Therefore, many
countries are worried about the destructive effects
of foreign equity outflow during a crisis. For
instance, some countries imposed rules to prevent
the outflow (Kim and Singal, 2000). Consistent with
these studies, Stiglitz (1998) argued that in
developing countries, there is more need for capital
flow controls since these countries are more
vulnerable to changes in international flows. An
attempt by Chakrabarti (2001) reflected that the FPI
net inflows were more likely the effect rather than
the cause of equity market returns, with the FPIs not
having informational disadvantages compared to
domestic investors. On the same lines, Mukherjee et
al. (2002) found that the FPI activities had a strong
demonstration effect and was driving the domestic
market indicating that the flow of foreign flows is
dependent on return in the domestic market. A study
by Rai & Bhanumurthy (2001) examined the
determinants of Foreign Portfolio Investments in India
by using monthly data. They found that FPI inflow
depends on stock market returns, inflation rate and
ex-ante risk. This study did not find any causation
EFFECTIVE MANAGEMENT
running from FPI inflow to stock returns as it was
found by some studies.
Li (2002) studied the impact of opening up
domestic market to foreign investors in Taiwan and
found no significant changes in stock market return
after market opening. But author agreed that the
impact on return should be there because large
international investors tend to study companies more
thoroughly.
3
 Gompers et al. (2001) proved that institutional
investors invested in liquid and large stocks having
low returns during the previous year. The study by
Chari and Henry (2002) using a unique data set of
daily returns of Indian banks provided evidence of
significantly positive valuation effect associated with
liberalization of foreign direct investment rules. Also,
Griffin (2004) found that foreign flows are significant
predictors of returns for Korea, Taiwan, Thailand and
India, indicating that foreign investors are buying
before market index increases. He also found that
simultaneous flows are positive and highly
significant in India. In tandem with these studies, a
study by Han et al. (2004) also analyzed the impact
of institutional investors on stock prices because of
the investment constraints on institutional investors
by their unit holders. Institutional constraints some
time refrain from selling or purchasing of stock about
which they have even some good/bad news. They
concluded that higher institutional investment
constraints have strong price momentum on the
shares. Another attempt was made in Indian context
by Badhani (2005) to examine the long-term and
short-term relationship among stock prices, dollar-
rupee exchange rate and net FPI investment in India,
using the monthly data of BSE sensex, dollar-rupee
exchange rates and net monthly FPI investment flows
from April 1993 to March 2004. The study showed
that there is co integration between net FPI investment
flow and stock prices. Related to the earlier studies,
Desai at el (2005) studied the FDI and domestic
capital stock during 1970 to 1980 and by applying
the regression, concluded that FDI has significant
impact on capital stock.
Ghosh, Harding and Phani (2005) conducted a
research on the effect of Liberalization of Foreign
Direct Investment (FDI) limits on domestic equity
prices in Indian banking sector. The analyses showed
that the price increase is higher for smaller banks
that have less debt, are less efficient, less productive,
and burdened with non-performing assets. They
EFFECTIVE MANAGEMENT
concluded that the evidence is consistent with the
hypothesis that the valuation gains reflect the
vulnerability to and premium of potential takeover
of the inefficient banks following the liberalization.
Continuing on the same lines, Goldar and Banga
(2006) examined the effect of trade liberalization on
foreign direct investment in Indian industries. An
econometric model was estimated to explain inter
industrial and inter-temporal variations in the extent
4 of foreign investment in manufacturing industries
using panel data for the post-reform period. The
results of the study indicated that trade liberalization,
particularly lowering of tariff rates, had a favourable
effect on foreign direct investment in Indian
industries. Another attempt was made by Lin et al.
(2006), who concluded that the performance of FPIs
high holding stocks is significantly better than that
of FPIs low holding stocks. Covering Indian aspect
of liberalization, Nayak (2006) conducted a research
on Globalization of Foreign Direct Investment in
India covering time from 1900s–2000. The study
revealed that today’s liberalized economy and
globalized structure of FDI in India have been an
outcome of the adjustment and alignment process of
the Indian Government to the dynamics of the various
domestic and international pressures and global
competition since the 1900s, and it is not merely a
phenomenon of post 1991 as popularly perceived.
Bekaert et al (2007) also demonstrated a positive
effect from the level of openness to foreign investors
to liquidity in emerging equity markets.
Adam & Tweneboah (2009) examined the
Foreign Direct Investment and Stock Market
Development in Ghana. The study was based on the
data of market capitalization as a proportion of GDP,
Ghana cedi-Dollar exchange rate and Net FDI inflow
quarterly data from 1991 to 2006. The analysis was
carried out using multivariate cointegration analysis
and Vector Error Correction Model (VECM). The
study concluded that FDI has significant influence
in the development of Ghana stock market and also
concluded that there is long-run relationship between
FDI and nominal exchange rate and stock market in
Ghana perspective. Lastly, I.Al-Halameh and Sayah
(2010) examined the impact of FDI on share market
in Amman. The study was carried out using primary
as well as secondary data from the report of Amman
Stock exchanges and data had been analysed using
multiple regression model. The study concluded that
FDI has significant Impact on share market.
OBJECTIVES OF THE STUDY
In the past few years, India has emerged as one
of the safe investment heavens in the eyes of various
foreign nations. The onus goes to the prosperous
economic growth and changing and relatively more
attractive foreign investment policies framed by the
government. Owing to the changed scenario, where
huge foreign investment flows have been witnessed
in Indian market associated with increased chances
of vulnerability and destabilization of an economy,
a need was felt to examine the impact of Foreign
Investments on the Indian Stock Market. The study
has been carried out primarily to examine the impact
of foreign investment flows in Indian stock market.
The specific objectives of the study are:
1. To analyse the impact of foreign direct
investment on Indian stock market.
2. To analyse the impact of foreign portfolio
investment on Indian stock market.
3. To identify and explore which form of foreign
investment causes major fluctuations in Indian
stock market.
HYPOTHESIS FORMULATION
In line with the objectives of the study, certain
hypotheses were formulated which are as follows:
Price Pressure Hypothesis
The rationale behind this hypothesis is that the
shocks from increased flows generate expectations
of additional future flows. This expectation is
reflected by the current price increase followed by
increase in expected future flows. When the expected
flows do not materialize in the future, the prices fall
(Froot et al., 2001). The theory of price pressure
hypothesis suggests that the rise in prices is associated
with increased inflows; based on this we expect to
see prices return to the fundamental when the actual
flows do not match the expected flows
(Ananthanarayanan et al., nd). The methodology of
Clark and Berko (1996) to test the price pressure
hypothesis is to add lagged values of net foreign
flows from the previous three months in the regression
with returns as dependent variable. For the hypothesis
to hold they expected to find these lagged inflows to
have significant negative coefficients, while the
contemporaneous coefficient to be positive. In an
ideal pure price pressure case, the positive
contemporaneous coefficient must be equal in
magnitude to the sum of the negative lagged
coefficients. Wang and Shen (1999) analysed that
large and sudden inflows may stimulate stock prices
while the outflow of FI may reduce equity value.
Chari and Henry (2002) provided evidence of
significantly positive valuation effect associated with
liberalization of foreign direct investment rules.
Dahlquist and Robertsson (2004) used a similar
approach, but they do not report how many lagged
inflows are analyzed.
The perusal of literature review revealed that
foreign trading impacts the returns of stock market.
But this effect can be only temporary, and so these
price movements may be due to lack of liquidity of
local markets. In this sense, foreign trading would
be harmful to the domestic financial markets, since
it generates more volatility thus, increasing the
chances of risk. To test this price pressure hypothesis,
as tested by Clark and Berko (1996) and Dahlquist
and Robertsson (2004), we framed the following null
hypothesis:
H0: There is no price pressure in Indian stock
market due to foreign investment inflows.
RESEARCH METHODOLOGY
The primary objective of this paper is to consider
the impact of foreign investment flows on the Indian
stock market. In this section, we explain how the
data were collected, provide some descriptive
statistics on the composition of the sample, and then
outline the correlation and multiple regression
methodologies that we used to assess the stock market
response.
The current study is an empirical research, as it
attempts to analyse statistical data in relation to the
predictor and the criterion variables related to foreign
investment (FDI and FPI) and stock market (Sensex).
Sensex was a natural choice for inclusion in the study,
as it is the most popular market index and widely
used by market participants for benchmarking. The
perusal of literature review revealed number of
variables in the ambit of foreign investment flows
and stock market. The three variables FDI, FPI and
Stock market have been taken up for the analysis in
the current study. Table 1 contains the description of
dependent and independent variables used in the
present study. Since the present study deals with
critical type of data related to foreign investment
flows, the data for the variables used in the research
has been collected from secondary sources. Month
end prices have been collected for all the variables
EFFECTIVE MANAGEMENT
from www.bseindia.com and www.rbi.com.
In the daily analysis we are constrained by the
availability of data. Daily data on FDI and FPI was
not available for sufficient time period. However data
on monthly basis, for both the sensex and the FDI
and FPI is available from January 2001 to February
2012 and so the analysis on the monthly basis is
undertaken for this reference period.
5
 Symbolically, the model on the impact of FDI
and FPI on India’s stock market (Sensex) can be
written as:
Sensext = ±0 + ±1 FDIt + ±2 FPI +ut —————
———— (1)
Where,
SENSEX = This has been taken as a proxy variable
for Indian stock market. The monthly end prices have
been extracted.
á0 = constant term
á 1 and á 2 = regression coefficient for respective
variables
ut = error terms
FDI = Foreign Direct Investment in Rs Crores. The
actual data are given in U.S $ Millions. The
conversion as fixed of $ into Rs has been made as
per the Exchange rates of the respective year.
FPI = Foreign Portfolio Investment in Rs Crores. The
actual data are given in U.S $ Millions. The
conversion as fixed of $ into Rs has been made as
per the Exchange rates of the respective year.
Statistical Tools and Techniques of Analysis
Hamao, Y. and Mei, J., 2001, Baker, Foley and
Wurgler, 2004 and Raza et al., 2012 have made use
of correlation and multiple regression methodologies
to test the existence of relationship between foreign
investment inflows and stock market. Following their
methodologies, in order to analyse the data in the
present study, Correlation and Multiple Regression
approach have been used. For this purpose, SPSS
has been meticulously used. Here SENSEX has been
taken as the dependent or the criterion variable and
FDI, FPI have been taken as the independent or the
predictor variables.
Correlation Analysis
The Bivariate Correlations procedure computes
the pairwise associations for a set of variables and
EFFECTIVE MANAGEMENT
displays the results in a matrix. It is useful for
determining the strength and direction of the
association between two scale or ordinal variables.
Under this Pearson correlation coefficients have been
computed which measure the degree of linear
association between two variables. The correlation
table shows correlation coefficients ranging in value
from –1 (a perfect negative relationship) and +1 (a
perfect positive relationship). A value of 0 indicates
no linear relationship.
Multiple Regression Analysis
Multiple Regression Analysis is a statistical
technique which analyses the linear relationship
between a dependent variable and multiple
independent variables by estimating coefficients for
the equation for a straight line. The linear regression
model assumes that there is a linear, or “straight line,”
relationship between the dependent variable and each
predictor variable. On the lines of the study based
on regression analysis carried out by Elder, Miao and
Ramchander (2012), in order to examine the impact
of foreign investment flows in India on the BSE
Index, univariate and stepwise regression analysis
has been applied. Stepwise regression analysis is
procedure in which the predictor variables enter or
are removed from the regression equation one at a
time. The purpose of this procedure is to select from
a large number of predictor variables a subset of
variables that account for most of the variation in
the dependent or the criterion variable.
RESULTS AND DISCUSSION
The results have been presented in two sections.
The first section briefs the results of correlation
analysis and second section covers the results of
multiple regression analysis. Table 2 shows the
Pearson correlation coefficients of the dependent and
the independent variables.
Table 2 shows the Pearson correlation
coefficients of SENSEX with inflows both FDI and

Table 1: Description of Dependent and Independent Variables

Variable Name Study Period andFrequency Data Source
INDEPENDENT VARIABLES

Foreign Direct Investment(FDI) Jan 2001 – February 2012Month end figure (in Rs.) Reserve Bank of India
Foreign Portfolio Investment(FPI) Jan 2001 – February 2012Month end figure (in Rs.) Reserve Bank of India
DEPENDENT VARIABLE
6 SENSEX Jan 2001 – February 2012Month end prices BSE India
Table 2: Correlation Analysis of Foreign Investment (FDI and FPI) with Stock Market (Sensex)
FDI FPI Sensex

FDI Pearson Correlation 1 -.011 .706**

Sig. (2-tailed) .896 .000
N 134 134 134
FPI Pearson Correlation -.011 1 .220*
Sig. (2-tailed) .896 .011
N 134 134 134
Sensex Pearson Correlation .706** .220* 1
Sig. (2-tailed) .000 .011
N 134 134 134
**Correlation is significant at the 0.01 level (2-tailed).
*Correlation is significant at the 0.05 level (2-tailed).

FPI. According to Pearson’s correlation the Multiple Regression Analysis

correlation coefficient of FDI and SENSEX is 0.706,
at 0.01 level of significance. Further the correlation
coefficient of FPI and SENSEX is 0.220, at 0.05 level
of significance. It can be inferred that FDI and FPI
have a significant and fairly strong positive
correlation with SENSEX, i.e., an increase in the FDI
and FPI results in corresponding rise in SENSEX.
The results of present study are in tandem with the
findings of Clark and Berko (1996), Bohn and Tesar
(1996), Brennan and Cao (1997), Wang and Shen
(1999), Bekaert and Harvey (2000), Mukherjee et
al. (2002), Griffin (2004), Badhani (2005), Desai at
el (2005), Adam and Tweneboah (2009) and I.Al-
Halameh and Sayah (2010).
Since both the variables have been found to be
associated with SENSEX, therefore further regression
analysis is used to investigate into the degree of
impact of both FDI and FPI on SENSEX.
In order to find out the contribution of foreign
investment inflows on the performance of the stock
market, multiple regression analysis was run where
SENSEX was taken as dependent variable. The
following tables present the results of regression
analysis.
Table 3: Impact of Foreign Investment Inflows on Sensex: Results from Univariate Regressions
Having established the nature of association of
foreign investments and BSE index, we now
investigate the degree of impact of foreign investment
inflows in India on sensex. In the first step we fit a
univariate regression model of the following form:
Y1 = a + b1X1 + b2 X2 + u——————— (2)
Where Y= BSE Index (SENSEX),
X1=Foreign Direct Investment; a= intercept,
b=regression parameter; u= standard error.
X2= Foreign portfolio Investment,
The table 3 reports the estimated univariate
regression models for the impact of fluctuating
foreign investment flows on the benchmark index
(Sensex).
Table 3 reports estimated coefficients with
corresponding standardized â values, t-statistics,
collinearity stats, adjusted R-squares, F-ratio and p-
values obtained from univariate regression models.
The standardized beta coefficients show how strongly
the independent variable is associated with the
dependent variable, when adjusted for standard error
to provide more comparable results. The t and Sig
EFFECTIVE MANAGEMENT

SENSEX
Optimal Regressors  T-stat Collinearity Statistics
Tolerance VIF
FOREIGN FDI .708 12.081 1.000 1.000
INVESTMENTS FPI .228 3.883 1.000 1.000
R2 .550
F- Ratio 79.985
p-value .000a
Source: Authors’ own.
Notes: a Indicate significance at the 1% level. 7
 (p) values give a rough indication of the impact of
each predictor variable – a big absolute t value and
small p value suggests that a predictor variable is
having a large impact on the criterion variable. The
F- test value helps to determine whether the model is
a good fit for the data. The variance inflation factor
(VIF) was used to assess the multi-collinearity and
the VIF scores ranged between 1.154 and 1.222.
Threshold values of tolerance above .10 (Hair et al.,
1998) and VIF scores of less than 10 suggest minimal
multi-collinearity and stability of the parameter
estimates (Neter et al., 1985; Dielman, 1991).
The results are discussed for foreign investment
inflows in India and performance of sensex. We
notice that when both the predictor variables were
taken together in univariate regression analysis, the
performance of BSE index was found to be sensitive
to foreign investment inflows but in different ways.
In particular, a significant relation was identified
between sensex and foreign investment flows in India
causing a variance of 55%, with an F-value of 79.985.
The results were significant at less than 1% level of
significance.
In addition to estimating the full model, we also
estimate a stepwise regression model that identifies
a restricted set of regressors in the joint model with
the most influential factors. Stepwise regressions
allow some or all of the independent variables in a
standard linear regression to be chosen automatically
from a set of variables. We also check for consistency
of the stepwise coefficients with the univariate model
containing all variables in the system. We also allow
for manual additions of selected factors from
categories that are not represented in the stepwise
approach. The stepwise regression results, which are
reported in Table 4, are largely consistent with the
univariate regression results discussed earlier.
The table 4 reports the estimated coefficients with
corresponding t-statistics, p-values and adjusted R-
squares obtained from stepwise regression models
for the influence of foreign investments in India on
EFFECTIVE MANAGEMENT
the benchmark index.
The regression equation for non-performing
assets on profitability and liquidity at aggregate level
is:
Y1 = a + b1X1 + b2 X2 + u——————— (3)
Where Y= SENSEX,
X1=Foreign Direct Investments; a= intercept,
b=regression parameter; u= standard error.
8 X2= Foreign Portfolio Investments
Table 4: Stepwise Models of Impact of Foreign Investment
Inflows on Sensex
SENSEX
Optimal  T-stat
Intercept 6408.773 12.481
FOREIGN FDI .706 11.443
INVESTMENTS
Adjusted R2 .498
F- Statistics 130.931
P-value .000a
Source: Authors’ own.
Notes: a Indicate significance at the 1% level.
Table 4 presents the regression results when
SENSEX is taken as the dependent variable and FDI
and FPI as predictors and stepwise regression is run.
We notice that foreign investment inflows in India,
have a significant impact on performance of the BSE
Index (Sensex). The stepwise regression picks up only
the FDI which causes fluctuations in sensex at the
1% significance level. In particular, FDI has a
positive bearing on performance of sensex. Here the
t-value for Gross NPA ratio is significant at less than
1% level of significance showing that it has a huge
impact on the index. It can be interpreted from the
results that FDI is the dominant variable having
significant relation and impact on Indian stock
market. The analysis so far demonstrates a new fact
about FDI flows: there is a very strong positive link
between source country stock market valuations and
FDI flows (Baker, Foley and Wurgler, 2004). Adam&
Tweneboah (2009), Claessens, Klingebiel, &
Schmukler (2001) and Kalim & Shahbaz (2009) also
have found positive and statistically strong
relationship between FDI and Stock Market (SM).
The results are consisietnt with the findings of Desai
at el (2005), Adam & Tweneboah (2009) and I.Al-
Halameh and Sayah (2010). Again, when second
independent variable FPI enters the equation in model
2, the total variance caused by a combination of both
the variables is increased to 53.7%.
In interpreting the adjusted R-square values, it is
worth pointing out that FDI indicator has the highest
degree of explanatory power in the regressions for
the BSE index (49.8%). The results also indicate that
alone foreign direct investment inflows in India cause
a variance of approx. 50% in sensex. It shows that
as the foreign investment inflows increase, it makes
the benchmark index to fluctuate in an upward
direction. The F- test value determines whether the
model is a good fit for the data. For the index, F-
ratio is 130.931, highly significant at less than 1%
level of significance, demonstrating that the model
is a perfect fit for the data. Further, the t-values for
FDI and FPI are significant at less than 1% level of
significance, indicating that the predictor variable is
strongly associated and having a large impact on the
criterion variable.
Thus, it can be analysed that the foreign
investment flows in Indian and Indian stock market
during 2001-12 are strongly associated. The findings
are in consistent with that of Clark and Berko (1996),
Bohn and Tesar (1996), Brennan and Cao (1997),
Wang and Shen (1999), Bekaert and Harvey (2000),
Mukherjee et al. (2002), Griffin (2004), Badhani
(2005), Desai at el (2005), Adam and Tweneboah
(2009) and I.Al-Halameh and Sayah (2010).
CONCLUSIONS
The Government of India in 1991 embarked on
liberalizations and economic reforms with a view to
bringing about rapid and substantial economic
growth and move towards globalization of the
economy. As a part of the reforms process, the
Government under its New Industrial Policy
revamped its foreign investment policy recognizing
the growing importance of foreign direct investment
as an instrument of technology transfer, augmentation
of foreign exchange reserves and globalization of
the Indian economy. Simultaneously, the
Government, for the first time, permitted portfolio
investments from abroad by foreign institutional
investors in the Indian capital market. Basically,
foreign direct investment relates to direct investment
in an Indian company either through a joint venture
agreement or as a wholly owned subsidiary with
management interest. Foreign investment can come
in two forms: Foreign Direct Investment (FDI) and
Foreign Portfolio Investment. After the opening up
of the borders for capital movement these investments
have grown in leaps and bounds. Increased foreign
inflows have a huge bearing on the stock exchange
barometer index Sensex. A strong surge in foreign
investment inflows helps boost the capital market.
A rich literature house is available on effect on
foreign flows on the performance of domestic stock
market have been carried out, however, still the world
is sans any consensus on same. In the past few years,
India has emerged as one of the safe investment
heavens in the eyes of various foreign nations. The
onus goes to the prosperous economic growth and
changing and relatively more attractive foreign
investment policies framed by the government.
Owing to this changed scenario, where huge foreign
investment flows have been witnessed in Indian
market associated with increased chances of
vulnerability and destabilization of an economy, a
need was felt to examine the impact of Foreign
Investments on the Indian Stock Market. The study
has been carried out primarily to examine the impact
of foreign investment flows in Indian stock market
and to explore which form of foreign investment
causes major fluctuations in Indian stock market.
In order to test the same it was hypothesized that
there is no price pressure in Indian stock market due
to foreign investment inflows. The perusal of
literature review revealed number of variables in the
ambit of foreign investment flows and stock market.
The three variables FDI, FPI and Stock market have
been taken up for the analysis in the current study.
Correlation and Multiple Regression approach have
been used in order to analyse the data in the present
study. Here SENSEX has been taken as the dependent
or the criterion variable and FDI, FPI have been taken
as the independent or the predictor variables.
The results of the correlation analysis revealed a
significant and fairly strong positive correlation with
SENSEX, i.e., an increase in the FDI and FPI results
in corresponding rise in SENSEX, consistent with
the findings of Clark and Berko (1996), Bohn and
Tesar (1996), Brennan and Cao (1997), Wang and
Shen (1999), Bekaert and Harvey (2000), Mukherjee
et al. (2002), Griffin (2004), Badhani (2005), Desai
at el (2005), Adam and Tweneboah (2009) and I.Al-
Halameh and Sayah (2010). The results also put forth
that alone FDI cause a variance of 48 percent in
SENSEX, which also demonstrates a new fact about
FDI flows: there is a very strong positive link between
source country stock market valuations and FDI
flows (Baker, Foley and Wurgler, 2004). Adam&
Tweneboah (2009), Claessens, Klingebiel, &
Schmukler (2001) and Kalim & Shahbaz (2009) also
EFFECTIVE MANAGEMENT
have found positive and statistically strong
relationship between FDI and Stock Market (SM).
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