FII Trading Activity and Intraday Volatility

This paper investigates whether the trading activity of foreign institutional investors adversely affects (intraday) volatility in the Indian stock markets. It reports that aggregate trading activity of FIIs dampens market volatility whereas aggregate trading activity of domestic investors exacerbates volatility. Further, the paper finds that positive shocks in aggregate trading activity have a greater impact than negative shocks; this asymmetry is stronger for aggregate domestic trades. Using a proprietary data set, the paper also relates individual stock volatility to tick-by-tick transaction volume, conditional on trader type and transaction type. The intraday results show that trading among FIIs does not increase stock volatility, but when FIIs sell to domestic clients or when domestic clients trade amongst themselves, volatility increases.

The authors are grateful to the Centre for Analytical Finance, Indian School of Business and Sankar De for sharing the NSE data (during Rajesh Chakrabarti’s association with the Indian School of Business) and to Bhargav Kali and Sesha Sairam for able research assistance. We are grateful to an anonymous referee for providing many insightful suggestions. The responsibility for all the errors and shortcomings rests solely with the authors.