Foreign Institutional Investments and Stock Returns in India: A Causality Test

This paper attempts to study the dynamics of the causality between FII inflows and stock returns in Indian capital market. Using the monthly data from May 1993 to August 2009 in the VAR framework, this study provides the evidence of level stationarity of net FII flows and stock returns. It is also found from the Johansen's cointegration analysis that there exists a long-run equilibrium relation between these two variables. Further, the Granger causality test suggests a unidirectional causality running from FII flows to stock returns in Indian economy. But no causality is seen from stock returns to FII flows. Thus, the policy makers should organize green pastures to attract the foreign institutional investment so as to enhance the process of capital formation and hence, to foster the pace of economic growth of India.