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The Relation between Investment of Domestic and Foreign Institutional Investors and Stock Returns in India

This study investigates the trading behaviour of foreign institutional investors (FIIs) and domestic institutional investors (DIIs) in the Indian stock market and also the relation between stock returns and equity flows by FIIs and DIIs. The study uses a wider definition of DIIs that includes not only mutual funds (MFs) but also banks, domestic financial institutions and insurance companies. The results show that the trading pattern followed by FIIs and DIIs is opposite of each other. While FIIs act as positive feedback traders, DIIs act as contrarian investors and negative feedback traders. High lagged stock returns result in increased FII investment. The DIIs, on the other hand, appear to book profits when the market moves up and buy when it moves down. Contrary to findings of earlier studies that MF investment has no effect on future stock returns, the study finds that DII investment has a significant positive relation with future stock returns. The study also finds weak evidence of a negative relation between FII investment and future stock returns.