Investment Behavior of Foreign Institutional Investors and Implied Volatility Dynamics: An Empirical Study on the Indian Equity Derivatives Market

Vijay Kumar Sharma (), Satinder Bhatia and Hiranmoy Roy
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Vijay Kumar Sharma: Indian Institute of Foreign Trade, New Delhi 110016, India
Satinder Bhatia: Indian Institute of Foreign Trade, New Delhi 110016, India
Hiranmoy Roy: School of Management, DIT University, Dehradun 248009, India

JRFM, 2023, vol. 16, issue 11, 1-14

Abstract: The aim of this study is to examine the association between the capital flows of foreign institutional investors (FIIs) in the equity derivatives market in India and the implied volatility of options. Previous studies on FIIs and realized volatility in the equity market provide the basis for this study. Covering a period of ten years (2012–2021), this study established the importance of FII capital flows in explaining the implied volatility of options. The Granger causality test confirms the unidirectional flow of causality between FII and implied volatility (VIX) in the Indian stock market. The vector autoregression model developed in the study confirms the dynamic relationship between implied volatility and the investment behavior of foreign institutional investors (FIIs). The outcome of this study will help options traders to understand the mispricing of options because of FII’s buying pressure on implied volatility. The results will also help policymakers understand how institutional investors influence option pricing so that appropriate decisions can be made.

Keywords: implied volatility; India VIX; FIIs; index options; Granger causality; VAR model (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2023
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