Foreign Investors Under Stress: Evidence from India

IMF Working Papers, May 22, 2013

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Emerging market policy makers are concerned about the financial stability implications of financial globalization, especially behavior under stressed conditions.
Core questions addressed:
- Do tail events in the home country trigger extreme responses by foreign investors — are foreign investors "fair weather friends"?
- Is there asymmetry between the response of foreign investors to very good versus very bad days?
- Do foreign investors have a major impact on domestic markets through large inflows or outflows — are they "big fish in a small pond"?
- Do extreme events in world markets induce extreme behavior by foreign investors, making them vectors of crisis transmission?
The authors propose a modified event study methodology focused on tail events to investigate these questions.

A modified event study methodology is developed and applied, with an emphasis on tail events (extreme positive and negative outcomes).

The evidence for India does not suggest that financial globalization has induced instability on the equity market.
The modified event study focused on tail events yields evidence relevant to:
- asymmetry in foreign investor responses to very good versus very bad days;
- the role of foreign investor flows in amplifying domestic market movements;
- the potential for world market extremes to induce extreme foreign investor behavior and crisis transmission.

Subject: Balance of payments, Capital controls, Emerging and frontier financial markets, Exchange rates, Financial markets, Foreign direct investment, Foreign exchange, Stock markets
Keywords: Capital controls, Emerging and frontier financial markets, Event study, event study analysis, event study approach, event study framework, event study methodology, Exchange rates, Extreme events, FII flow, flat event study response, Foreign direct investment, foreign investor, Foreign investors, Global, Stock markets, WP