Does Foreign Institutional Investment in India Increase Financial Vulnerability? An Empirical Investigation Using an Event Study Approach

Emerging market policymakers are concerned about the effects of foreign portfolio flows on financial stability. Do tail events in the home country trigger off extreme responses by foreign investors and is there any asymmetry between the responses of foreign investors to very good versus very bad days? Do foreign investors have a major impact on domestic markets through large movements of funds? Do extreme events in world markets induce extreme behaviour by foreign investors, thus making them vectors of crisis transmission? This project examines these questions for India, using a modified event study methodology focussed on tail events. The researchers analyse data for individual companies and find that, while on good days, foreign investors exacerbate the boom by bringing in additional capital, no significant effects are found on very bad days in the local economy.

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