Policy information uncertainty and trading behavior of foreign institutional investors

This paper examines the impact of policy–related information uncertainty (PIU) on the trading behaviour of foreign institutional investors (FII) in emerging equity markets. We undertake an empirical analysis using transaction–level data and exploiting a quasi–natural experiment set–up provided by an unexpected tax–related policy announcement in the Indian equity market that generated a period of policy uncertainty. Our results show that FII reacts quickly and withdraws, on average, investments worth at least 0.713 basis points of the market capitalization (USD 0.17 million) per day for average equity during the PIU period. However, the sentiments of the FII turn significantly positive when the concerned PIU is eradicated. The results suggest that policymakers, particularly in capital constraint emerging markets, should be highly conscious of generating PIU if they wish to attract and retain overseas investors.