Policy information uncertainty and foreign institutional investors trading behavior: evidence from India

Abstract Using transaction–level data and exploiting a credible quasi–natural experiment set provided by India’s unexpected tax–related policy announcement, we examine the impact of policy–related information uncertainty (PIU) on the trading behavior of foreign institutional investors (FII). Based on transaction–level data, we compute the daily net equity trading by all FII of each listed Indian firm. We find that FII reacts quickly and withdraws significant investments during the PIU period. However, the investments of the FII do not become positive immediately when policymakers eliminate the relevant PIU. Further analysis reveals that the impact of PIU subdues and FII equity flow returns to the pre–PIU level in the long term. The results suggest that policymakers, particularly in capital–constrained emerging markets, should be highly conscious of generating PIU if they wish to attract and retain overseas investors.