Impact of Foreign Direct Investment, Foreign Institutional Investment, and Exchange Rate on BSE Sensex: An Econometric Analysis Using ARDL and ECM Approaches

This paper empirically investigates the impact of Foreign Direct Investment (FDI), Foreign Institutional Investment (FII), and the USD/INR exchange rate on the Bombay Stock Exchange (BSE) Sensex using monthly data from April 1995 to May 2026 (259 observations after cleaning). The study employs a comprehen-sive econometric framework including: (1) Unit Root Tests (ADF and KPSS) for stationarity analysis, (2) Autoregressive Distributed Lag (ARDL) Bounds Test for co-integration, (3) Error Correction Model (ECM) for short-run dynamics, and (4) Granger Causality Tests for directional relationships. The empirical results reveal that FDI, FII, and exchange rate collectively explain approximately 90.4% of the variation in Sensex movements in the long-run. The ARDL Bounds Test shows no co-integration with an F-statistic of 3.087 falling below the lower bound at 10% significance. However, the long-run OLS model shows strong relationships: a 1% increase in FDI is associated with a 0.28% increase in Sensex, while a 1% increase in FII leads to a 0.18% increase in Sensex. The exchange rate shows a strong positive coefficient (1.82), indicating that INR depreciation is associated with higher Sensex levels. The ECM results show that approximately 2.96% of short-run disequilibrium is corrected monthly,confirming slow adjustment to long-run equilibrium. Granger causality tests reveal bidirectional causality between FII and Sensex, and between FDI and FII. Sensex Granger-causes FDI, FII, and USD unidirectionally. Diagnostic tests indicate the model has no serial correlation but exhibits heteroscedasticity and non-normality. These findings have important implications for policymakers and investors in emerging markets, suggesting that foreign capital flows play a crucial role in deter-mining stock market movements. The strong bidirectional relationships highlight the interconnected nature of foreign investment flows and stock market performance.