Behavioural Finance Perspectives On FII Trading - Impacts On Liquidity And Market Stability
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BEHAVIOURAL FINANCE PERSPECTIVES ON FII
TRADING: IMPACTS ON LIQUIDITY AND MARKET
STABILITY
Nayeisha Puri, Army Institute of Law, Mohali
ABSTRACT
Foreign Institutional Investors (FIIs) have been pivotal in shaping the Indian capital markets, significantly influencing market dynamics and liquidity through their substantial capital inflows and outflows. While their investments enhance market depth and liquidity, they also introduce volatility due to their often-reactive trading strategies. Although extensive research has been conducted on the quantitative impacts of FIIs on market performance, the behavioural finance perspective—examining the psychological drivers behind their investment decisions—remains underexplored. FIIs, including hedge funds, insurance companies, pension funds, investment banks, and mutual funds, have played a crucial role in the development of the Indian capital markets since the economic liberalization of the 1990s.
Their investment decisions are influenced by a combination of economic indicators, market conditions, and strategic objectives aimed at optimizing returns and managing risks. This article delves into the behavioural aspects of FIIs, focusing on how cognitive biases, emotions, and social influences can lead to irrational investment behaviours that impact market liquidity. The study contrasts the current cautious approach of FIIs with the aggressive investment patterns of Domestic Institutional Investors (DIIs), who have increased their investments nearly threefold compared to the previous year. This surge in domestic investments has been a key factor in driving the stock market rally, supported by a broader trend of financialization of savings in India.
The findings highlight the growing influence of domestic investors, particularly DIIs and retail investors, who have consistently viewed market dips as buying opportunities, thereby stabilizing the market during periods of volatility. This behavioural resilience contrasts with the more reserved stance of FIIs, whose reduced investment levels reflect caution amid global uncertainties. The analysis underscores the need for a deeper understanding of FII behaviour for market regulators and participants, as their actions have substantial implications for market stability and the overall health of the
financial system. While FIIs contribute positively to market growth and liquidity during stable periods, their behaviour during volatile times can exacerbate market fluctuations, posing challenges for market management and policy formulation. This article provides insights into the changing dynamics of market influence, emphasizing the critical role of behavioural finance in understanding the interplay between FII actions and market liquidity. Introduction Foreign Institutional Investors (FIIs) play a crucial role in the Indian capital markets, and they have considerable influence on price movement, market dynamics, and liquidity as well. As these large investments pour in and out of the market, they almost always create sharp movements in stock prices and trading volumes that affect liquidity.
There has been a dearth of literature on behavioural finance aspects despite extensive research evidence available with respect to the quantitative dimension of FII investments and their impact thereafter on market performance. They are bodies that exist outside a country, which invest large amounts in securities of companies situated within such countries. It was all supported and patronized by hedge funds, insurance companies, pension funds, investment banks, and mutual fund houses. FIIs became significant players in the Indian capital markets in the early nineties when the opening of the economy by the government took place as part of broader economic liberalization. Due to the large quantum of capital being flown into investing markets, FIIs are supposed to be an essential consideration by any market in a nation.
Their portfolio decisions are based on a combination of economic signals, market conditions, and strategic factors that optimize returns with risk management. Among emerging markets, the Indian capital market— consisting of BSE and NSE—has grown through privatization and liberalization due in part to FIIs. While it has its benefits, the massive participation of FIIs can also bring in risks like market volatility on strong capital acceptance and rejections. Insights into the behaviour of FIIs, especially with respect to psychological foundations influencing their investment decisions, can help in addressing these risks and improving liquidity in the markets. Behavioural finance, the study of the influence of psychology on the actions performed by financial participants and global traders, provides a special prism to comprehend FIIs' actions.
The conventional finance theories assume investors are rational beings and the market works systematically. But
behavioural finance questions this by including cognitive biases, emotions, and social effects which may result in unreasonable investment behaviours. Literature Review The influence of FIIs on emerging markets, especially in India, has garnered significant scholarly attention due to their substantial impact on market dynamics and liquidity. FIIs are pivotal in enhancing market liquidity by increasing the volume of trade and facilitating more efficient price discovery processes. Their large-scale transactions ensure a continuous flow of buying and selling, thereby reducing bid-ask spreads and enhancing market depth. Research by Batra (2003)1 and Chakrabarti (2001)2 highlights a positive correlation between FII investments and market liquidity, attributing the influx of substantial capital and trading activity to these institutional investors.
Behavioural finance examines the psychological influences and biases that affect investor behaviour, challenging the traditional finance assumption of rationality. Key behavioural factors include overconfidence, herding behaviour, loss aversion, and market sentiment, all of which significantly impact investment decisions and market outcomes. Shiller (2003)3 and Barberis & Thaler (2003)4 have extensively discussed these concepts, demonstrating how cognitive biases and emotional factors can lead to irrational investment behaviours that deviate from traditional economic theories. Incorporating behavioural finance theories into the analysis of FII activities provides deeper insights into the psychological drivers behind investment decisions. Overconfidence among FIIs can lead to excessive trading, increasing market volatility, as discussed by Odean (1998)5.
Herding behaviour, where FIIs follow each other's investment patterns, is particularly prevalent during periods of market stress, amplifying market trends and contributing to significant market movements (Sias, 20046; Bikhchandani & Sharma, 20007). 1 Batra, A. "The Dynamics of Foreign Portfolio Inflows and Equity Returns in India. " ICRIER Working Paper No.
109 (2003), available at https://www.icrier.org/pdf/wp109.pdf.
2 Chakrabarti, R. FII Flows to India: Nature and Causes, 2 Money & Fin. 61, 61-81 (2001).
3 Shiller, R. J. From Efficient Markets Theory to Behavioural Finance, 17 J. Econ. Persp. 83, 83-104 (2003) 4 Barberis, N., & Thaler, R. A Survey of Behavioural Finance, in Handbook of the Econ. of Fin. 1, 1053-1128 (2003). 5 Odean, T. Volume, Volatility, Price, and Profit When All Traders Are Above Average, 53 J. Fin. 1887, 1887-1934 (1998).
6 Sias, R. W. Institutional Herding, 17 Rev. Fin. Stud. 165, 165-206 (2004)
7 Bikhchandani, S., & Sharma, S. Herd Behaviour in Financial Markets, 47 IMF Staff Papers 279, 279-310 (2000).
Market sentiment, influenced by global economic conditions and geopolitical events, plays a crucial role in shaping FII investment decisions. Positive sentiment typically leads to increased FII inflows, whereas negative sentiment results in outflows, impacting market liquidity. Research by Baker & Wurgler (2007)8 and Kaminsky et al. (2004)9 underscores the significant influence of market sentiment on FII behaviour, demonstrating how shifts in global sentiment can lead to substantial capital movements in and out of emerging markets like India. The relationship between FII activity and stock market liquidity is well-documented in the literature. FIIs enhance liquidity by increasing trading volumes and narrowing bid-ask spreads, contributing to more efficient markets. Bekaert et al. (2007)10 provide evidence that FII investments are associated with higher liquidity in emerging markets.
However, the actions of FIIs can also lead to increased volatility, particularly during periods of market uncertainty, as highlighted by Karolyi (2002)11. Despite the extensive body of literature on FIIs, behavioural finance, and stock market liquidity, several research gaps remain, particularly concerning the integration of behavioural finance perspectives into the study of FII activities and their impact on market liquidity. While there is an acknowledgment of behavioural biases such as overconfidence, herding, loss aversion, and market sentiment, there is limited empirical research that quantifies these factors specifically in the context of FIIs' investment behaviours in Indian markets.
Existing research predominantly focuses on the aggregate market impact of FII investments, lacking detailed analysis of how behavioural biases among FIIs influence their investment patterns across different sectors and how this affects sector-specific liquidity. Furthermore, while some studies touch upon the impact of FIIs during market crises, there is insufficient research on how specific behavioural biases influence FII decision-making during periods of extreme market stress and the subsequent effects on liquidity. The impact of technological advancements, such as algorithmic trading and high-frequency trading, on the behavioural patterns of FIIs and market liquidity is another underexplored area, including how technology might exacerbate or mitigate behavioural biases. 8 Baker, M. , & Wurgler, J. Investor Sentiment in the Stock Market, 21 J. Econ. Persp. 129, 129-152 (2007).
9 Kaminsky, G. L. , Lyons, R. K. , & Schmukler, S. L. Managers, Investors, and Crises: Mutual Fund Strategies in Emerging Markets, 64 J. Int'l Econ. 113, 113-134 (2004). 10 Bekaert, G. , Harvey, C. R. , & Lundblad, C. Liquidity and Expected Returns: Lessons from Emerging Markets,
20 Rev. Fin. Stud. 1783, 1783-1831 (2007).
11 Karolyi, G. A. Did the Asian Financial Crisis Scare Foreign Investors Out of Japan?, 10 Pac.-Basin Fin. J. 411, 411-442 (2002).
This article seeks to address a critical lacuna in the literature by focusing on the behavioural aspects of FII investments and their resultant impact on market liquidity. Despite the significant role of FIIs in shaping market dynamics, there exists a limited understanding of the psychological factors that drive their investment decisions and how these factors subsequently affect liquidity. Psychological factors such as overconfidence, herding behaviour, loss aversion, and market sentiment are pivotal in influencing FIIs' investment decisions. Overconfidence may lead to excessive trading activities, whereas herding behaviour can result in FIIs mimicking each other's investment strategies, thereby amplifying market trends.
Loss aversion, characterized by the propensity to avoid losses rather than acquiring equivalent gains, can cause FIIs to react disproportionately to market downturns, consequently affecting liquidity. Additionally, market sentiment, influenced by global economic conditions and geopolitical events, plays a crucial role in shaping FII decision-making. This research will delve into these behavioural factors and their subsequent effects on market liquidity within the Indian context. By integrating behavioural finance theories with empirical analysis, this study aims to provide a comprehensive understanding of how psychological biases influence FII behaviour and market outcomes. This approach not only addresses a significant gap in the extant literature but also offers valuable insights for policymakers, regulators, and market participants aiming to enhance market stability and efficiency.
Understanding the psychological drivers behind FII investment patterns can inform the development of regulatory frameworks designed to mitigate market volatility and promote liquidity. Research that integrates behavioural finance insights into the formulation of regulatory policies for FIIs is sparse, and exploring how behavioural biases can inform more effective regulatory frameworks would be a valuable contribution. Addressing these research gaps can significantly enhance the understanding of the behavioural aspects of FII investments and their impact on stock market liquidity, contributing to both academic knowledge and practical policymaking, ensuring a more stable and efficient market environment.
Data Analysis Since the start of the year, Domestic Institutional Investors (DIIs) have significantly increased their investments in the Indian stock markets, contributing ₹3,01,684 crore by 21 August—
almost three times the ₹1,08,887 crore they invested during the same period last year. Meanwhile, FIIs have scaled back their involvement, reducing their investments to ₹15,940 crore, a sharp decline from ₹1,40,105 crore a year ago. Mean Median Range Mean Median Range Mean Media Range Statistic Std Buy Std Sell Std Net Buy Buy Buy Sell Sell Sell Net n Net Net
DII
5.20 13,341.0 3,885.98873.62 12,949.5 11,175.2 3.44 6,783.2 2,485.7 2,690.
542.80 1,025.80
18,853.6 16,775.7 7,366.59 14,286.8 16,957.8 14,831.2 6,042.8 11,510. 1,895.8 1,944. 1,388.7
FII/FPI
2,776. 20 *based on data as from 23 Aug 24 to 29 Aug. 24. **all values are in ₹ Crores. The correlation between the net value of FII and DII trading activities is 0. 775, indicating a strong positive relationship. This suggests that when FIIs are net buyers or sellers, DIIs tend to show similar net trading behaviours, although not perfectly aligned. Comparative Insights • Volatility: FIIs demonstrate significantly higher volatility in both their buy and sell activities compared to DIIs. This is evident from the larger standard deviations and ranges in FII data, which could be indicative of more aggressive trading strategies and responsiveness to market conditions. • Trading Volumes: FIIs show significantly higher trading volumes (mean BUY VALUE: ₹18,853. 67 crores) compared to DIIs (mean BUY VALUE: ₹15,435. 20 crores).
This suggests that FIIs, due to their larger global capital base, tend to engage in higher volumes of trade, which can lead to greater market liquidity.
Net Buying/Selling Activity: FIIs' net buying activity shows more variability (higher standard deviation: ₹1,388. 74 crores) compared to DIIs (standard deviation: ₹542. 80 crores). This variability indicates that FIIs are more reactive to market conditions, potentially leading to greater fluctuations in market liquidity. However, DIIs have consistently higher net buying (mean NET VALUE: ₹2,485. 70 crores) compared to FIIs (mean NET VALUE: ₹1,895. 80 crores), suggesting that DIIs might play a stabilizing role in the market, especially when FIIs reduce their market exposure. • Liquidity Implications: The strong positive correlation between FII and DII net values suggests that both sets of institutional investors may amplify market trends when they engage in similar buying or selling activities.
This synchronized behaviour could enhance liquidity during bullish periods but might also exacerbate liquidity issues during market downturns if both groups decide to sell simultaneously. • Market Impact: Given that FIIs have larger and more volatile trading volumes, their impact on market liquidity is likely more pronounced, especially during periods of significant inflows or outflows. DIIs, with their relatively stable and consistent net buying, may provide a buffer against extreme liquidity fluctuations caused by FII trading behaviour. • Behavioural Implications: The observed volatility in FII activities aligns with the notion of FIIs being momentum traders or "return chasers," as they adjust their buying and selling in response to market movements.
This behaviour may lead to short-term liquidity surges followed by periods of reduced liquidity, especially when FIIs withdraw from the market. This analysis indicates that while both FIIs and DIIs play crucial roles in influencing market liquidity, FIIs have a more variable impact, which could lead to periods of both enhanced and reduced liquidity depending on market conditions. DIIs, on the other hand, appear to offer a more stabilizing influence on market liquidity, particularly in times of market stress. Time series analysis of FII inflows and market liquidity measures. Since the beginning of the year, there has been a noticeable shift in how DIIs and FIIs approach the Indian stock market. DIIs have dramatically increased their investments, pumping in nearly three times more money than they did last year. This robust domestic investment has been a key
driver behind the stock market rally, as evidenced by the Nifty 50's impressive 14% gain. 12 On the other hand, FIIs have significantly reduced their investments, cutting them down to a fraction of what they invested last year. This divergence in behaviour highlights the growing confidence and active participation of domestic investors, who have consistently viewed market dips as opportunities to buy, helping the market quickly recover from various downturns. This pattern reflects a broader shift towards financialization of savings in India, where more money is being directed into equities, supported by a favourable economic outlook and structural trends like rising incomes and increased savings.
While this domestic enthusiasm has been a stabilizing force, it also underscores the changing dynamics of market influence, with domestic investors increasingly taking the lead in driving market performance, even as global investors like FIIs take a more cautious approach. Results and Discussion This analysis underscores the importance of understanding FII behaviour for market regulators and participants, as their actions have substantial implications for market stability and the overall health of the financial system. The findings suggest that while FIIs contribute positively to market growth and liquidity during stable periods, their behaviour during volatile times can exacerbate market fluctuations, posing challenges for market management and policy formulation. DIIs have markedly increased their investment activity, nearly tripling their inflows compared to the previous year.
This surge in domestic investments has been a major factor in the stock market rally, with the Nifty 50 index gaining 14% since the start of the year. In contrast, FIIs have considerably reduced their investments, reflecting a cautious approach amidst global uncertainties. 13 Increased FII inflows are typically associated with higher market liquidity, as they bring substantial capital and trading activity into the market. However, the reduction in FII inflows
12 Dipti Sharma, FIIs have stepped back, but the stock market has a new pillar mint (2024),
https://www.livemint.com/market/stock-market-news/diis-inflows-markets-retail-investors-hnis-nifty-50financialization-oecd-regulatory-reforms-11724388595632.html (last visited Aug 29, 2024).
13 Dipti Sharma, FIIs have stepped back, but the stock market has a new pillar mint (2024),
https://www.livemint.com/market/stock-market-news/diis-inflows-markets-retail-investors-hnis-nifty-50financialization-oecd-regulatory-reforms-11724388595632.html (last visited Aug 29, 2024).
this year suggests that domestic investors are increasingly driving market liquidity, compensating for the decline in foreign investment. Behaviourally, DIIs and retail investors have shown resilience, consistently viewing market dips as buying opportunities, which has contributed to the market's quick recovery from various downturns. This shift in market dynamics underscores the growing influence of domestic investors in shaping market trends, even as FIIs adopt a more reserved stance. The research article "Foreign Institutional Investments and Liquidity of Stock Markets: Evidence from India" 14provides an insightful analysis of how FII activities influence stock market volatility in India. The study reveals that FIIs play a significant role in shaping market dynamics, particularly in terms of market volatility and liquidity.
One of the key findings is that FII trading behaviour—marked by substantial gross purchases and sales—contributes to heightened market volatility. This volatility is largely driven by the nature of FII transactions, which tend to involve large volumes of capital moving in and out of the market quickly, often in response to global economic conditions or shifts in investor sentiment. Their study employs various statistical measures, such as the Amihud illiquidity ratio, turnover ratio, and bid-ask spreads, to quantify the impact of FII flows on market volatility. It is observed that an increase in FII purchases and sales tends to elevate these liquidity measures, indicating lower market liquidity and higher volatility.
Specifically, the Amihud illiquidity ratio, which measures the price impact of trades, rises with greater FII activity, suggesting that the market becomes more volatile as FIIs trade more frequently and in larger volumes. This relationship is further corroborated by the positive correlation between FII flows and bid-ask spreads, where higher spreads reflect increased transaction costs and reduced liquidity, thereby exacerbating market volatility. FIIs are often described as momentum traders or "return chasers," meaning they tend to buy stocks that have been performing well and sell those that have been underperforming. This behaviour can amplify market trends, leading to periods of excessive volatility. For instance, during market upswings, increased FII buying can drive prices higher, while during downturns, rapid selling by FIIs can lead to sharp declines.
The study’s findings suggest that this behaviour contributes to a cycle of volatility, where FII actions based on short-term gains can destabilize 14 Krishna Prasanna & Bharat Bansal, Foreign Institutional Investments and liquidity of stock markets: Evidence from India, 6 International Journal of Economics and Finance (2014).
the market, making it more prone to sudden swings in prices. FIIs in India exhibit a strong tendency towards positive feedback trading, particularly over short horizons. 15 This means that FIIs are more likely to increase their investments following periods of rising stock prices, which is indicative of momentum trading or "return chasing. " When FIIs engage in positive feedback trading, they inject substantial capital into the market during periods of rising prices. This influx of funds increases trading volumes and enhances market liquidity. Higher trading volumes ensure that buy and sell orders are executed more efficiently, reducing bid-ask spreads and improving overall market depth. However, the impact of FII flows on market liquidity is significant but short-lived.
16 This suggests that while FIIs can provide a temporary boost to liquidity, their influence may wane as the initial momentum fades. This short-term liquidity surge can be beneficial for traders seeking quick entry and exit, but it may not sustain long-term market stability. Although FIIs enhance trading volumes and market depth in the short term, their tendency to withdraw capital quickly when market conditions change leads to sudden drops in liquidity, further increasing volatility. While FIIs are crucial for bringing capital into emerging markets like India, their trading patterns significantly influence market stability, often leading to increased volatility and reduced liquidity in times of market stress.
1. Implications for Investors
The findings highlight the increasing influence of DIIs and retail investors in driving market performance, suggesting a shift in the balance of power from FIIs to domestic participants. For investors, this trend implies that domestic sentiment and local economic conditions will play a more significant role in market movements than before. Investors may need to pay closer attention to domestic factors, such as savings rates, economic policies, and earnings outlooks for Indian companies, as these will likely have a more substantial impact on market trends. Additionally, the resilience of DIIs and retail investors in treating market dips as buying opportunities suggests that corrections may present valuable entry points rather than signals of sustained downturns. 15 Batra, A. (2003). "The Dynamics of Foreign Portfolio Inflows and Equity Returns in India. " ICRIER Working Paper No. 109.
Retrieved from ICRIER. //Chakrabarti, R. (2001). "FII Flows to India: Nature and Causes. " Money & Finance, 2(7), 61-81.
16 Ibid.
2. Implications for Policymakers
For policymakers, the findings underscore the importance of maintaining a favourable investment environment that continues to attract both domestic and foreign capital. The substantial increase in domestic investments reflects growing confidence in India's economic prospects; however, the reduction in FII inflows highlights the need for policies that support global investor confidence. Policymakers should focus on enhancing macroeconomic stability, improving regulatory transparency, and ensuring a competitive tax regime for equity investments. Given the structural shift towards greater financialization of savings, policies that encourage further investment in equities, such as favourable tax treatments and promoting systematic investment plans, could help sustain market growth.
3. Implications for Market Regulators
Market regulators should consider the implications of heightened domestic participation on market stability and liquidity. With DIIs and retail investors playing a more dominant role, regulators need to ensure that the market infrastructure supports robust liquidity and fair-trading practices. This includes monitoring market volatility, ensuring adequate liquidity provisioning, and being prepared to intervene in the event of significant market disruptions. Additionally, regulators should focus on protecting retail investors by promoting investor education, transparency, and ensuring that market corrections are not exacerbated by regulatory barriers or policy missteps. The shift in investment dynamics also suggests a need for continuous evaluation of market regulations to adapt to changing investor behaviours and to foster an environment that supports sustainable market development.
Overall, the findings highlight the evolving landscape of the Indian stock market, where domestic investors are increasingly driving market outcomes. This shift presents opportunities but also challenges, requiring a coordinated approach from investors, policymakers, and regulators to sustain the market's growth trajectory and enhance its resilience against external shocks. Policy Measures India has progressively liberalized regulations for FIIs since the 1990s, aimed at making Indian markets more accessible and attractive to foreign capital. Key measures include simplifying the
registration process for FIIs, expanding the range of financial instruments available for investment, and increasing the investment limits in various sectors. These initiatives have facilitated greater FII participation, significantly enhancing market liquidity by increasing trading volumes and deepening market engagement. The liberalization efforts have positioned India as an appealing destination for foreign investors, contributing to a more dynamic and liquid capital market. Tax incentives have also played a crucial role in attracting FII inflows. India has entered into Double Taxation Avoidance Agreements (DTAAs) with numerous countries, reducing the tax burden on foreign investors and making Indian markets more attractive.
Additionally, specific tax exemptions, such as the absence of long-term capital gains tax on listed securities until recently, have further incentivized foreign investments. While these measures have been effective, the frequent changes in tax policies, such as the reintroduction of long-term capital gains tax on equity investments, have introduced uncertainties that could deter FIIs from committing long-term capital, thereby impacting market liquidity. Another significant policy measure has been the relaxation of investment caps for FIIs. The Indian government has progressively increased foreign ownership limits in various sectors, allowing FIIs to hold up to 24% in Indian companies, with the possibility of extending this limit with the approval of the company's board and shareholders.
This relaxation has enabled FIIs to make larger investments, enhancing their influence and boosting market liquidity. However, sector-specific restrictions, particularly in sensitive areas like defence, telecommunications, and media, still pose challenges, limiting broader FII engagement in these sectors. The introduction of Participatory Notes (P-Notes) has also been a notable policy measure to enhance FII participation. P-Notes allow FIIs to invest in Indian securities without undergoing direct registration, providing an alternative route for foreign investors who seek anonymity or wish to avoid the procedural complexities of direct registration.
While P-Notes have contributed to increasing FII inflows and market liquidity, concerns over the lack of transparency and potential misuse for money laundering have led to regulatory scrutiny and tighter controls, balancing the benefits with the need for oversight. To further enhance market liquidity through FII participation, several policy suggestions can be considered. Firstly, maintaining a stable and predictable tax regime is crucial. Policymakers should aim to reduce the frequency of changes in tax policies affecting FIIs, thereby providing
a more predictable investment environment that encourages long-term commitments from foreign investors. Simplifying the tax structure and offering consistent tax incentives would further boost investor confidence and sustain FII inflows. Secondly, expanding the scope of FII investments by gradually relaxing sector-specific restrictions could attract more diverse and substantial foreign investments. While safeguarding national interests is essential, a balanced approach that carefully considers the economic benefits of increased FII participation in restricted sectors could be advantageous. For instance, a phased relaxation of investment caps in non-sensitive sectors could serve as a pilot for broader reforms. Enhancing transparency and streamlining regulatory processes could also significantly improve FII participation.
Simplifying compliance requirements, reducing procedural delays, and providing clearer guidelines on investment rules would make the Indian market more accessible and appealing to foreign investors. Additionally, maintaining stringent but fair oversight of instruments like P-Notes can ensure that they continue to contribute to market liquidity while mitigating risks associated with misuse. Lastly, promoting India as a stable and attractive investment destination on the global stage is vital. Efforts should include strengthening macroeconomic fundamentals, ensuring political stability, and advancing structural reforms that improve the ease of doing business.
By building a robust economic narrative and emphasizing India's long-term growth prospects, policymakers can attract sustained foreign investments that enhance market liquidity and support the broader development of the Indian capital markets. Conclusion The findings underscore the critical role of behavioural finance in understanding FII activities and their impact on market liquidity. FIIs contribute positively to market liquidity during stable periods but can exacerbate volatility and liquidity risks when they rapidly alter their positions in response to market conditions. In contrast, the stable investment patterns of DIIs suggest a more consistent contribution to market liquidity, highlighting the importance of domestic sentiment in shaping market trends. For investors, the results imply that greater attention should be given to domestic factors, as
DIIs and retail investors increasingly drive market movements. For policymakers, the challenge lies in maintaining a favourable environment that supports both domestic and foreign investments, emphasizing macroeconomic stability and regulatory transparency. Market regulators need to adapt to the changing landscape by ensuring robust liquidity and fair trading practices while protecting retail investors through education and transparent regulations. Overall, the evolving dynamics of the Indian stock market, with a shift towards domestic investor influence, present both opportunities and challenges. A coordinated approach from investors, policymakers, and regulators is essential to sustain market growth and resilience, ensuring that the benefits of increased domestic participation are fully realized while managing the potential risks associated with volatile foreign investments.