How does foreign institutional investment affect market efficiency in developing stock markets?

This research investigated the qualitative way in which Foreign Institutional Investors (FIIs) impact the efficiency of stock markets in developing countries. The primary focus of this research was to determine the impact of FIIs on market efficiency in three developing countries; India, Brazil, and South Africa. The findings of this study demonstrate that FIIs have a long-term positive effect on market efficiency in developing countries through different elements of market efficiency, i.e., price discovery, liquidity, and the quality of corporate governance. It is primarily because many developing countries have relatively low levels of local participation in their equity/capital markets compared to the amount of foreign investment into their local market provided by FIIs. The research demonstrates that FIIs also create short-term volatility at certain times, due to the speculative nature of many foreign investment trades, particularly following extreme levels of current and past foreign trade inflows or outflows. In summary, this study shows that FIIs are not only an additional source of improved market efficiency through the use of intensive amounts of FII trading, but FIIs also increase market risk through the speculative nature of many foreign trade transactions; which can ultimately lead to significant losses to market participants. The results from this type of future research would likely also provide additional knowledge and understanding about developing market economies, by way of using comparative analysis between multiple developing countries, in regards to the FII-to-market value relationship.

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