Problemstatement
FIIflows,oftenreferredtohotmoney withshort- termandspeculativec h a r a c t e r , areextremelyvolatilecomparedtootherformsof capitalflows.Foreignportfolio investorswhocomeinwhentheycangainmoneyi nmarketandleaveitrightawaywhentheyrecognizeimpendingtroublehencedes tabilizetheeconomyo f thehostcountry.Moreover,securitiesmarketofVietnamiss mallandimmaturewhereastheforeignfundsarenowsobig,possiblytodominatethe capitalmarket.H e n c e , theremaybethepotentialofthatFIIcapitalfliesoutof Vietnammarket,drivethepricesdownsharplytherebyinduceconsiderableinstabilityinthe Vietnams t o c k market.
However,theissueofwhetherFIIflowaffectsstock marketreturnor ina co n t rar y directionis stillon controversy.An analysis ofthedirectionof causalitytou n d e r s t a n d t h e p o s s i b l e e f f e c t ofv o l a t i l i t y ofF I I f l o w o n t h e do mesticf i n a n c i a l marketa n d e c o n o m y i s i m p o r t a n t fromt h e viewpointo f policym a k e r s N e v e r t h e l e s s , thisissuestillremainsunresolved.
Researchobjectives
Researchscope
Thiss t u d y j u s t f o c u s e s o n H o ChiMinhS t o c k E x c h a n g e ( H O S E ) onlyt o determinetherelationshipbetweenFIIflowandstock marketreturn becauseHOSEc a n representtoVietnamstockmarketduetothelargesizeofHOSEi ncapitalasw e l l asbustlingforeigntradingactivities.
Researchquestions
DoesFII flow volatility haveshort-term or long-termeffect on thes t o c k marketreturnvolatilityand/orviceversa?
Thesisstructure
Accordingly,t h e r e m a i n d e r of t h e pap er is or gan ize das fo ll ow s T h e n ex t c h a p t e r dealswithliteraturereviewwhilethethirdchaptershowsthedata source,researchm e t h o d o l o g y a n d h y p o t h e s i s C h a p t e r f o u r d i s c u s s e s t h e f i n d i n g s o f t h e c a s e study.Finally,conclusions, policyimplicationsandlimitationsarepresentedinc h a p t e r five.
Theorybackground
Thetheorysaysthatlocal investorscomprehend about local financialmarketmoret h a n f o r e i g n i n v e s t o r s , l e a d i n g t o a p o s i t i v e f e e d b a c k t r a d i n g byf o r e i g n p o r t f o l i o i n v e s t o r s A p o s i t i v e f e e d b a c k t r a d i n g s t r a t e g y l e a d s t o buyo r
Decisions to sell or buy stocks can significantly impact stock prices, leading to increased foreign investment inflows Conversely, selling or buying during rising or falling stock prices is viewed as negative feedback trading Local investors, benefiting from insider information, may trade stocks based on new insights, causing price fluctuations that attract foreign investors who react to these trends Local investors are seen as information traders, while foreign investors are classified as positive or negative feedback traders, responding to market movements Bikhchandani and Sharma (2001) proposed a theory on mutual fund behavior, highlighting that investors often adjust their portfolios based on sudden price changes, exhibiting either positive or negative feedback behavior by buying high and selling low or buying low and selling high.
Thecontrariantheoryofflowsaffectingcontemporaneousandfuturest ockmarketreturnscoexists Froot, O'Connell an dSeasholes (2001)showedt hatinternationalportfolioflowsledpricechanges.Theacceptableexplanationfo rther e v e r s e directionofcausalityfromFIIflowstostockmarketreturnsisthe'herdin gbehavi or' o f f o r e i g n i n v e s t o r s A c c o r d i n g t o P a r k a n d S a b o u r i a n ( 2 0
1 1 ) , herdingb eh a v i o r i s inw h i c h agentss w i t c h b e h a v i o r f r o m b u y i n g t o sellingo r i n thec o n t r a r y direction,followingthecrowd.Theseherdersactagainsttheiro wni n f o r m a t i o n andmaketheirinvestmentdecisionsbasedontheothertraders’ decisions.I n f o r m a t i o n externalitiesh a v e c o n d i t i o n e d r a t i o n a l h e r d i n g too c c u r Accordingly,rationalherdinghappenswhenagents’owninfor mationislesse f f i c i e n t o r n e v e r r e v e a l e d t o p u b l i c ( R e d d i n g , 1 9 9
6 ) b e c a u s e i t i s c o v e r e d byi n f o r m a ti o n ofothertraders’observeddecisions.Moreover,phenomenonofmutualinvestorswhowatchtheotherinvestors’behaviorfortra dingisconsideredherdingb e h a v i o r (Bikhchandani&Sharma,2001).
Empiricalstudies
In the 1990s and 2000s, various studies examined the relationship between Foreign Institutional Investor (FII) flow and domestic stock market returns, yielding mixed results Malarvizhi and Jaya (2009) investigated the impact of FII flow on the Indian stock market, specifically using the National Stock Exchange (NSE) as a representative index Their findings revealed a unidirectional causal relationship, indicating that FII flow positively influenced stock market returns, particularly the Nifty Index, while there was no evidence of the reverse effect In contrast, other studies, such as those by Brennan and Cao, have suggested different dynamics in this relationship.
99 7) f ou ndapositivecorrelationbetweenFIIflowandstockmarketreturn.Thispositiver e l a t i o n s h i p isexplainedduetoinformationdisadvantageofforeigninvestors andt h en theytradeasmomentumtraders.Evidencefromcausalitytestscondu ctedbyMukherjee,B o s e a n d Coondoo(2002)suggestedt h a t F I I f l o w s toa n d f r o m t h e domesticmarkettendedtobecausedbyreturnsinthedomesticequitymarketb utn o t inacontrarydirection.GordonandGupta(2003)indicatedthatlaggeddomestics t o c k marketreturnhadanegativeeffecttoFIIflow.
Subsequently,byu s i n g dailyd a t a , B o s e a n d C o o n d o o ( 2 0 0 4 ) f o u n d l i g h t eviden ce ofbidirectionalcausalrelationshipbetweenreturnonthestoc kindexofB o m b a y S e c u r i t y E x c h a n g e ( B S E ) a n d F I I n e t i n f l o w C h a k r a b o r t y ( 2 0 0 7 ) u s e d m o n t h l y dataobtainedfromBSEandemployedpair- wiseGrangercausalitytesttoinvestigatethec a u s a l r e l a t i o n s h i p b e t w e e n F I
I f l o w a n d s t o c k marketr e t u r n i n India.Theyhavefoundtheevidenceofbidirection alcausalitybetweenFIIflowands t o c k marketreturn,whereasFII flowis morecausedbystock marketreturn.WhileB a b u andPrabheesh(2008)employed VAR approach, Gr angercausality testand dataondailybasisfromNSE,theyhavealsofoundtheexistenceofbidirectional cau sal relationshipbetweenFIIflowandstockreturninIndiastockmarket,wher easFIIflowismoredrivenbystockreturn.Lai,LowandShiu(2008)studiedin
T S E 1, triedusingpair-wiseGrangercausality testand foundthesameresult thatF I I tendstobeamomentumtraderandconversely,theycanpredictthestockreturn.J o (20 02)employedacombinationofTwoStageLeastSquaredandARCHmodelstosho wthatFIIflowsinducedagreatervolatilityinmarketcomparedtodomestici n v e s t o r s i n K o r e a n s t o c k m a r k e t P a v a b u t r ( 2 0 0 4 ) u s e d modifiedG A R C H (
1 , 1 ) toidentifytheimpactofFIIflowtostockreturnvolatilityandfoundt h e eviden ce of th at foreignnet flowhaspositiveeffectonmarketvolatility Rai a n d
Bhanumurthy (2004) analyzed monthly data from January 1993 to November 2002 to investigate the impact of stock returns, market risk, and other real factors on Foreign Institutional Investor (FII) flows into India Utilizing the TARCH model to capture the asymmetric effects of good and bad news that lead to volatility in returns, the study found that stock returns are the primary driving force behind FII investments, with foreign investors responding more strongly to negative news than positive news The research suggests that stabilizing stock market volatility could attract more FII However, no evidence was found to support a reverse causal relationship from FII to stock returns.
2 0 0 1 t o December3 1 s t , 2 0 0 9 a n d employedGrangercausalitytest,VAR model,Waldtest,Im pu lse ResponseF u n c t i o n toidentifytheinvestmentbehavi orofvariousinstitutionalinvestors.FII’sar ef o u n d t o b e e n g a g e d i n t h e p o s i t i v e f e e d b a c k t r a d i n g a c t i v i t i e s a n d c a u s i n g volatilityinIndianstockmarket.
Period&freq uencyofdata Market Methodology Keyvariables Findings
FII(netpurchasesinqua rtertexpressedasaprop ortionoftheaverageab solutelevelofnetpurcha seso v erthepreviousfo urquarters)
Korea TSTL(twoStag eLeastSquares) ARCHmodel
FIIflowsinduc esagreatervol atilityinmarket scomparedtod omesticinvesto rs
- FII(netinvestmentas aproportionofthesizeo fmarketcapitalizati on)
4 Korea Composite StockPriceIndex andnotinacontr arydirection
Laggeddomesti cSMRh as aneg ativeeffecttoFI Iflow
Lightevidenceo fbidirectionalc ausalrelations hipbetweenre turnonthestock indexofBSEan dFIInetinflow
Stabilizationo fstockmarketv olatilitywou ldattractmoreFII.T h e reversecausald irectionhasn otbeenfound.
- FII(netFIIflowsasapro portionoftheprecedin gmonth'sBSEmarketc apitalization) -SMR(BSESensex)
Bi- causalrel atio nshipbetwee nFIIflowandS MR,whereasFI Iflowismoreca usedbySMR
India VAR approach,Gran gercausalitytes t,ImpulseRes ponseFunction
Theexistenceof bidirectionalc ausalrelations hipbetweenFIIflowandSMR,whereasFIIflo waremoredrive nbySMR
India VARmodel,G rangercausali tytest,Impulse Responsefunct ion,covarian cedecompositi on
FII’sarefoundto beengagedinth epositivefeedb acktradingacti vitiesandcausi ngvolatilityinI ndianstockmar ket
Foreign Institutional Investment (FII) Stock market return
Conceptualframework
Datasource&variables
Aperiodofeightconsecutivefinancialyearsrangingfrom2004to2011is selectedf o r empiricalstudy.B e s i d e s d a t a o f t h e w h o l e p e r i o d , formorer o b u s t testing,wedividetherangeintotwosub- periods:The1 sti s fromJan.2004toDec.2 0 0 7 and the 2ndo n e i sfromJan 2008to Dec.
2011.Itmeansthat wetestthe causalrel ati on sh ip betweenFIIflowandstockmarketreturnbeforeandduringf inancialcrisis.
MonthlynetFIIflows(i.e.,grosspurchases─grosssalesbyforeigninvestors )intotheVietnamequitymarketandmonthlystockmarketreturnwhicha r e calcul ateddatafromthesecondarydataobtainedfromHOSEwebsitesuchasgr oss pu rchases,grosssalesbyforeigninvestors,valueofclosingVN-
Index.H o w e v e r , t h e t w o p r o x i e s be l o w a r e c o n s i d e r e d s u i t a b l e c h o i c e for es t i m a t i o n t o investigatethecausalitybetweenFIIflowandstockmarketreturninVietnam
MonthlyreturnonVN-Index(R): Rt=(Pt–Pt-1)/Pt-1t:Month
In the study by Chakraborty (2007) and Lai, Low, and Shiu (2008), the ratio of monthly net Foreign Institutional Investor (FII) flow to monthly trading volume is utilized as a measure of FII flow Monthly trading volume is preferred over monthly market capitalization or the value of outstanding shares in the context of Vietnam, where the percentage of deposited shares as a proportion of registered shares is only seventy, and the trading volume percentage is even lower Thus, this proxy effectively reflects the activity of foreign investors in the Ho Chi Minh Stock Exchange (HOSE).
Indexiscalculatedastheratiooftheexcessofindexv al u e ina specificmonthovertheprecedingmonthto precedingmonth’sVN-indexv a l u e
Methodology
UnitRootTest
iis theestimatorofthelaggedfirstdifferenceofYttistime βiscorrespondingcoefficientu tis w hitenoiseerrorterm.
H0:UnitRoot,=0(Dataisnotstationaryandneedstobedifferenced) H a:Stationary,