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The impacts of capital flows on vietnam stock market luận văn thạc sĩ

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

VIETNAM- NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACTS OF CAPITAL FLOWS ON
VIETNAM STOCK MARKET.

BY

TRAN TUYET HANH

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, NOVEMBER 2012



UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM- NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACTS OF CAPITAL FLOWS ON
VIETNAM STOCK MARKET.
A thesis submitted in partial fulfilment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

TRAN TUYET HANH

Academic Supervisor:

DR. NGUYEN HOANG VU

HO CHI MINH CITY, NOVEMBER 2012


DECLARATION

I hereby certify that the substance of the thesis has not already been submitted for
any degree and is not being currently submitted for any other degree.
I also certify that, to the best of my knowledge, and help received in preparing the
thesis and all sources used have been acknowledged in the thesis.

Signature

TRAN TUYET HANH


Date: ..................... .


ACKNOWLEDGMENTS
i

I would like to express my gratitude to all those who gave me the possibility to complete
this thesis.
I am deeply grateful to my supervisor Dr. Nguyen Hoang Vu from Department of
Mathematic and Statistics, Dr. Nguyen Trong Hoai-Vice President, Dr. Pham Khanh Nam
from Department of Development Economics , University of Economics Ho Chi Minh
City whose support, stimulating suggestions and encouragement helped me in all the time
of research for writing this thesis.
I am also very grateful to all lecturers of the Vietnam-Netherlands Programme for giving
me knowledge and guidance to fulfill the M.A Programme.
I would like to thank all the members of the Vietnam-Netherlands Program, especially,
VNP Library for helping me to have necessary documents and research papers during my
completion of the thesis.
Finally, I am indebted to my parents whose love, sympathy and encouragement enabled me
to complete this thesis.
encouragement.

I am also thankful to my classmates for their warm


ACRONYMS AND ABBREVIATIONS

FDI

Foreign Direct Investment

FPI

Foreign Portfolio Investment

FII

Foreign Indirect Investment

WTO

World Trade Organization

VSM

Vietnam Stock Market

HOSE

Hochiminhcity Stock Exchange

HNX

Hanoi Stock Exchange

PIE

Price-earning

VN-Index

Vietnam Index

IPO

Initial Public Offering

OTC

Over The Counter Market

LDCs

Less Developed Countries

liP

Index of Industrial Production

VAR

Vector Auto regression

ADF

Augmented Dickey Fuller

pp

Phillips Peron

ECM

Error Correction Model

SBV

State Bank of Vietnam

sse

State Securities Commission of Vietnam

CPI

Consumer Price Index


ABSTRACT
This thesis investigates the impacts of FPI flows on Vietnam stock market (VSM).
In other words, we aim to examine whether a long-run or short-run impact of FPI
flows on VSM exists or not. And, if any, how long does it take for changes to be
fully effective? We use the mol!thly time series data of VN-Index and FPI flows
from July 2000 to June 2012 to analysis. In order to calculate the growth rate of
VN-Index, we take logarithm ofVN-Index series and denote it as Delta-VN. Then,
we adopt various techniques on time series regression such as unit root test using
both Augmented Dickey Fuller (ADF) test and Phillips Peron (PP) test for
stationary, co-integration test using Engle &Granger approach and Johansen
approach for examining the existence of a long-run relationship between two
variables, Granger Causality test for checking the existence and direction of
causality relationship between them, error correction models for investigating the
existence of short-term relationship. Moreover, we also apply Serial Correlation LM
test, Heteroskedasticity ARCH test, Histogram Normality test to check the
appropriateness of the estimated model. The research findings show that there is an
unilateral effect from FPI flows on Vietnam stock returns. The thesis also illustrates
an existence of a long-run impact between them when an increase in FPI flows can
lead to 86% of increase in Vietnam equity returns. On the other hand, there is also a
short-run impact from FPI on VSM which would be decreasing gradually since the
third month.


----------------------------------------------------

TABLE OF CONTENTS
CHAPTER 1. INTRODUCTION ................................................................................. !
1.1 Problem statement ...................................................................................................... 1
1.2 Research objectives .................................................................................................... 4
1.3 Research questions ..................................................................................................... 4
1.4 Research scope .......................................................................................................... 4
1.5 Structure of the thesis ................................................................................................ 5

CHAPTER 2. LITERATURE REVIEW ..................................................................... 6
2.1 The role ofFPI on economic development.. .............................................................. 6
2.2 The role of Vietnam Stock Market ........................................................................... 7
2.3 Theoretical framework ................................................................................. 8
2.3.1Foreign Portfolio Investment and stock market .......................................... 9
2.3.2 Conceptual framework .................................................................... 11
2.4 Empirical studies ...................................................................................... 13
2.5 Suggested research model.. .......................................................................... 15
2.6 Chapter remark ........................................................................................ 16

CHAPTER3. RESEARCH METHODOLOGY&DATA COLLECTION ............ 17
3 .1 Econometric techniques ........................................................................................... 17
3 .1.1 Stationary and unit root tests .................................................................... 17
3 .1.2 Co integration ............................................................................................ 18
3 .1.3 Granger Causality tests .......................................................... 18
3.1.4Error correction mechanism ...................................................... 19


3.2 Data collection ......................................................................................................... 20
3 .3 Data analysis ............................................................................................................ 22
3.3.1 Dependent variable: Delta-VN ................................................................ 22


3.3.2 Independent variable: FPI ........................................................................ 23
3.3.3 Interaction between FPI flows and VN-Index ......................................... 23
13.3 Chapter remark ........................................................................................................ 33

CHAPTER 4. EMPIRICAL ANALYSIS .................................................................. 35
4.1 Structural Break Point test ....................................................................................... 35
4.2 Unit root test ............................................................................................................ 35
4.3 Co-integration test. .................................................................................... 36
4.4 Granger Causality test ................................................................................. 38
4.5 Error Correction Model.. ............................................................................ 39
4.6 Chapter remark ........................................................................................ 38

CHAPTER 5. CONCLUSION AND POLICY RECOMMENDATIONS ............. 43
5.1 Main findings ........................................................................................................... 4 3
5.2 Policy recommendation ........................................................................................... 44
5.3 Research limitation and suggestion for further study ............................................. .45

REFERENCES ............................................................................................................. 46
APPENDIX A.

DESCRIPTIVE STATISTIC ........................................................ 49


LIST OF GRAPHS
Graph 3.3-1: Delta-VN=log(VN-IndexJVN-Index(-1)) ............................................... 22
I

Graph 3.3-2: Foreign portfolio investment flows (FPI) to Vietnam from July 2000
to June 2012 ....................................................................................... 23
Graph 3.3-3: FPI&VN-Index from July 2000 to June 2012 ................................. 24

LIST OF TABLES
Table 4.1-1: Summary of structural breakpoint test ...................................................... 35
'fable 4.2-1: Summary of unit root test results .............................................................. 36
Table 4.3-1: Summary of unit root test results for residuals using ADF&PP test:
Engle &Granger test ...................................................................................................... 36
Table 4.3-2: Summary of Johansen cointegration tes~··················································· 37
Table 4.3-3: Summary of Trace Statistic value ............................................................. 38
Table 4.4-1: Summary of Granger Causality test .......................................................... 38
Table 4.5-1: Summary of testing Vector Error Correction Model ................................ 39
Table 4.5-2: Summary of the tests for approriateness of the estimated model ............. 41


LIST OF FIGURES
Figure A-1: Structural Breakpoint Test for Delta-VN variable ..................................... 49
I

figure A-2: Structural Breakpoint Test for fPI variable ............................................... 49
figure A-3: Unit root test for Delta-VN variable .......................................................... 50
figure A-4: Unit root test for FPI variable .................................................................... 52
figure A-5: Cointegration test (Engle &Granger method) for residuals from the
linear regression for two variables ................................................................................. 54
figure A-6: Results of the Johansen Cointegration test for model2 ............................. 55
figure A-7: Results of the Johansen Cointegration test for model3 ............................. 57
Figure A-8: Results of the Johansen Cointegration test for model4 ............................. 58
Figure A-9: Results of the Granger Causality test ......................................................... 59
figure A-1 0: Results of the Vector Error Correction Model.. ....................................... 60
Figure A-ll: Results of the Wald test ........................................................................... 61
Figure A-12: Results of the Serial Correlation test ...................................................... 61
Figure A-13: Results of the Heteroscedastiscity test .................................................... 63
. Figure A-14: Results of the Histogram Normality test ................................................. 64




CHAPTER 1: INTRODUCTION
I

This chapter will introduce the thesis topic and identify the problems going to be
analyzed in the thesis. It gives the research objectives, research questions and
research scope. This chapter also provides the structure of thesis.

1.1

Problem statement

After the official joint to the World Trade Organization (WTO) in 2007, Vietnam
has been opening the financial market, economy and trade. With the competitive
advantages of lower production cost and investment risk than in other Southeast
Asian countries, Vietnam has become an attractive destination of foreign capitals.
Vietnam is making a good impression on international investors because it is
expanding rapidly in emerging market and obtaining dramatic growth after the



global financial crises in 2008. Due to government's gradual relaxing macro
policies on foreign investment restrictions in the stock market, Vietnam has further



enhanced attraction to international equity investors.
About the regulations on foreign share holding rate, Vietnam has raised the
percentage of foreign holding rate from 30% up to 49%. These regulations are
rather suitable for Vietnam Stock Market (VSM) in this developing period.
About the regulations on profit transferring outflows, in order to encourage foreign
investors we have offered duty-free on this kind of outflows since 2004 for
Vietnamese foreigners and foreign residents.
On July 28, 2012 Vietnam stock market (VSM) was 12 years old with some
notable achievements when it reached more than 1.2 million transaction accounts,
1,690 public companies, 105 securities companies, 4 7 fund management
companies and 23 stock investment funds. Market capitalization accounted for

1


27% of GDP. Till May 31, total loans for securities of whole banking systems
were about 12 trillion VND, bad debt at 485 billion VND.
I

The July average trading volume reached 41.83 million shares per session with the
average value of 626.3 billion VND (down 37% in volume and -43,9% in value
I

frbm June). On July, VN-Index ended at 414.5 points, down 10.9 points from June
(see Economic Financial report Jul2012).
Additionally, foreign investors' transactions were still remammg gloomy. On
Hose, they bought 56.4 million shares valued at 1,377 trillion VND and sold 50
million shares valued at 1,292 trillion VND. Net purchase value in July was 86
billion VND while in June, foreign investors posted net sale of 650 billion VND.
On HNX, foreign players also posted net purchase of nearly 60 billion VND. (See
Economic Financial report Jul 20 12)
In fact, FPI flows into Vietnam have been increasing rapidly in recent years.
Especially, since Vietnam officially joined WTO in 2007, FPI flows have
increased strongly, accounting for more than 50% of total foreign investment
capitals. In the 2008 global financial crisis, the FPI flowed out; the stock market
fell 66%, from 921 points to 316 points and caused bad effects on macro economy.
Then, along with the economic recovery, the stock market witnessed a net inflow
of FPI capitals but the stock market rarely crossed 500 points, with mini-recoveries
inevitably followed by lengthy slumps. On theory, FPI flows can benefit an
economy in three broad ways. First, FPI inflows can provide a non-debt capital
source of foreign investment for a developing country and supplement domestic
savings for improving the investment rate. Moreover, FPI also reduces the pressure
of foreign exchange gap for the less-developing countries. Second, rises in foreign
capital inflows can increase the allocated efficiency of capital in a country.
Therefore, FPI can induce financial resources to flow from capital-abundant
countries to capital-scarce ones. Consequently, resource flows into the capitalscarce countries reduce their capital cost, increase investment and raise output.
Third, through its various linkage effects via the domestic capital market, FPI

2


affects the economy by giving an upward thrust to the domestic stock market
prices, impacting on the price-earning (PIE) ratios of the firms and making these

..

ratios become higher which lead to a lower cost of finance and in tum attract a
higher amount of investment. Consequently, the lower cost of capitals can
encourage new equity issues with higher premium. On the other hand, FPI flows
also stimulate the domestic stock market's development when it opens the entry for
foreign investors
In Resolution No.01/NQ-CP dated March 01, 2012 on key solutions to realize the
socio-economic development plan and state budgeting for 2012, the main targets
for economic development in 2012 have been set up such as about 6% to 6.5 %in
the GDP growth rate, 13% in total export growth , import surplus accounted for
11% -12% of total export turnover , controlling trade deficit under 10%, the
overspending in state budget controlled less than 4.8% of GDP, total capitals
invested in social development accounting for 33.5% of GDP, the expansion in the
consumer price index less than 10%, 1.6 million employed workers, the urban
unemployment rate remaining at 4%.
So, they aim to these objectives: prioritizing curbing inflation by applying tight,
cautious and flexible monetary policy in accordance with the tight and effective
fiscal policy, stabilizing the macro-economy, maintaining growth rate at a
reasonable level by reinforcing the inspection of market and prices, wellorganizing the domestic market, encouraging exports, controlling imports and
reducing trade deficit. On the other hand, they also object to growth model
renovation, the national economy restructure and improvement in the quality
performance and competitiveness of the national economy and enhancement in the
performance of external relations and international integration by these solutions:
restructuring investments focused on public investments, restructuring the financial
and banking system, especially on commercial banks, restructuring enterprises
focused on SOEs.

3


Despite a huge amount of empirical researches on stock market behaviors, most
~tudies

have focused on the major well- established markets or on the other macro

factors' influences on stock markets. Thus, an increased knowledge of how foreign



portfolio investments influence on Vietnam stock market (VSM) is a practical
interest to investors and financial researchers.
Therefore, finding the impacts of FPI flows on Vietnam Stock Market, especially
in the long-run, will help policy makers improve policies to attract more FPI flows
and achieve national economic objectives.

1.2 Research objectives
The thesis' objectives include:

...



To examine the impacts ofFPI on Vietnam Stock Market (VSM).



To recommend general policies for sustainable development in VSM to
encourage more FPI flows into Vietnam .

1.3 Research questions
The thesis aims to answer the following questions:


Is there a long-run or short-run impact ofFPI flows on VSM?



Is it correct to say that VSM takes time to be fully adjusted after any
changes in FPI flows? So how long does it take for the change to take
effect?

1.4 Research scope
i

The research focuses on finding the impacts of FPI flows on Vietnam Stock Market.
So we only investigate monthly time series data of net FPI flows and VN-Index
from July 2000 to June 2012.

4


1.5 Structure of the thesis
I

1fhis thesis has five chapters which are organized as follows:
I



Chapter 1 explains reasons why to choose this topic for research, the
research's significance, main objectives, some research questions and the
scope of the research.



Chapter 2 provides an overview on theoretical background of FPI impacts on
VSM which are expressed in general through the conceptual framework.



Chapter 3 presents the research methodology. Based on the other empirical
researches, we draw out the study framework. This chapter also describes the
general econometric models, variables, data collection which are explained
the reasons for choosing variables included and reliable sources to collect
data.



Chapter 4 shows the statistic results from adopting the econometric model
above. Findings are analyzed to answer the research questions in the chapter
1.



Chapter 5 obtains the main findings and recommends sustainable policies to
improve VSM in order to encourage FPI flows.

5


CHAPTER 2: LITERATURE REVIEW

the main purpose of this chapter is to review theoretical and empirical literature for
the links among FPI & VSM. This chapter is divided into five main parts. The first
and second parts contain the concepts and the roles of FPI & VSM to economic
growth. The third part, theoretical frameworks include some theories about the
relationship between FPI and stock market, conceptual framework. The fourth part
presents empirical studies about the impacts from FPI flows on stock market in
detail. The final part suggests the research model.

2.1 The role of FPI on economic development.
~apital

flows including short-term portfolio flows and long-term investments have

.related to economic development and even to infrastructure development. To boost
1



economic growth and expand resources for development finance, governments

usually promote international capital inflows, strengthen capital markets in order to
encourage efficient financial markets.

According to Bakardzhieva et al (2000),

capital flows were clarified into several types. "Three distinctive flows appear in the
financial account of balance of payments, namely foreign direct investments (FDI),
portfolio investments and other investments". In this paper, we just focus on
portfolio investments into the Vietnam stock market. These flows are referred as the
foreign portfolio flows (FPI) in Vietnam.
Foreign Portfolio Investment (FPI) represents passive holdings of securities such as
foreign stocks, bonds or other financial assets, none of which entails active
management or control of the securities' issuers by the foreign investors. However,
they can sell off easily the securities and pull out the portfolio investment.
Therefore, FPI is much more volatile than FDI. For developing countries, FPI can
bring rapid development, helping an emerging economic opportunity, job creations,

6


and significant wealth. When an economic takes a downturn, or fails to meet the
expectations of international investors, the huge capital inflows can be withdrawn
grammatically. According to World Bank (2001), the external problem of excessive
capital outflows were as follows: the capital outflows above critical threshold levels
might impact adversely on the domestic economy by draining foreign exchange
reserves, reducing the resources available for domestic investment, and slowing the
developing of the financial sector. However, the World Bank (2001) report also
found that there was an existence of a strong relationship between FPI with
domestic investment. In the other word, in a research on some East Asia economies
during 1990s of Henry (2000), stock market liberalization on trading might lead to
investment booms. But, capital inflows might not lead to economic growth because
it occurs in conjunction with a set of domestic complementarities for capital
absorption, retentive capabilities, and consequent impact on production and
consumption. In fact, global financial integration only allows greater ease in the
entry and exit of capital.

_

2.2 The role of Vietnam stock market (VSM).

The State Securities Commission, part of the Ministry of Finance, has been
managing the Vietnam stock market. They have issued a Law on Securities in June
2006 to facilitate the development of the securities market speedily and sustainably
by covering the regulation of listing and trading securities, the State's roles in
administering and inspecting the securities market. There are two stock exchanges
in Vietnam, one in Hanoi and one in Ho Chi Minh City. The Ho Chi Minh stock
exchange was inaugurated in July 2000 and became a main Vietnam stock exchange
with approximately 280 companies listed. We use the measure of VSM expressed
as VN-Index quoted in the Ho Chi Minh stock exchange. It is a capitalizationweighted index of all the companies listed on the Ho Chi Minh Stock Exchange.
The index was created with a base index value of 100 as of July 2000. In order to

7


estimate the growth rate of VN-Index, we take the logarithm of VN-Index over lag
one ofVN-Index and named this variable as Delta-VN.
Stock markets bring benefits to corporations, individual investors and governments.
'

For corporations, by making an Initial Public Offering (IPO) on the stock exchange,
a corporation can gain access to a huge amount of investors, raise capitals by
attracting abundant capital resources for their business. Moreover, access to the
stock markets also facilitates growth by merger or acquisition through share
purchases. For investors, stock markets are able to help them improve returns by
diversifYing their choices of different corporations and industries to invest. Equities
cannot ensure a fixed rate of return. Thus, they become a riskier investment than
money markets or bonds. What equities provide is the prospect of a combination of
income and capital gains, plus a superior rate of return. For the economy, stock
markets can put people's savings to work, the economy cannot get benefits or just a
little from individual cash savings or bank accounts. Stock investment is a direct
method in the success of businesses and helps promote stronger economic growth.
In the other word, stock markets are also a measure of the economy's performance.
In general, the performance of share prices is a good indicator of its current
condition and of the confidence of individuals within that economy. So, in some
extent, the performance of the stock market is correlated with the health of the
economy. Moreover, the strict regulations and requirements for corporation's stock
to be listed on the stock exchange and maintained on trading are a good way for
investors to ensure corporate governance because management standards and
standards of record keeping within that corporation are maintained at a high level.
For governments, stock markets can give access to funds because the stock
exchange allows individuals to lend money to their government when government
may issue bonds quoted on the stock market to raise money for infrastructure or
major projects.

8


2.3 Theoretical frameworks
7here are many researches on the role of FPI flows through the stock market into
emerging market economies.

2.3.1 Foreign Portfolio and stock market.
Theoretically, many economists and researchers have the different viewpoints about
the relationship between FPI and stock returns in domestic economies.
The first theory is to support the unilaterally impacts from FPI flows on stock
returns. According to Clark and Berko (1997) who investigated the economically
and statistically significant positive correlation between monthly foreign purchases
of Mexican stocks and Mexican stock returns, a percent increase in foreign inflows
led to 13 percent increase in Mexican stock prices. Additionally, Choe et al (1999),
who examined foreign investors' impacts on the Korean stock index from
November 1996 to the end of 1997, found evidences of foreign investors' positive
trading and herding before the Korea economic crisis. However, there was no
evidence that the foreign investors· transactions had a destabilizing impact on the
Korean stock market during their sample period. The Korean stock market was
adjusted quickly and efficiently by large sales of foreign investors. On the other
hand, Bose and Condoo (2004), who studied the impact ofthe FII policy reforms on
FII portfolio flows to the Indian stock market through a multivariate GARCH
regression model, strongly suggested that liberalization policies had had the desired
expansionary effect and obtained a sensitive impact of FII inflows to a change in
BSE returns.
The second theory is to illustrate the viewpoint that there is no correlation between
FPI flows and stock returns. According to Singh and Weisse (1998) who examined
two major components of financial liberalization : stock market development and
portfolio capital flows in the scenarios of less developed countries (LDC), LDCs
should pay attention on strengthening their banking systems rather than stock

9


markets because their banks could promote long-term economic growth and
1

industrialization. Moreover, they were able to suffer the burden of globalization

1without speculative portfolio inflows. In addition, Pal (2006), who aimed to
examine the impact of Foreign Portfolio Investment on Indian economy through the

1

I

stock market, showed that the perceived benefits of foreign portfolio investment
had not been utilized in India. The prediction that the foreign portfolio investors
would boost economy through a country's stock market did not work in India.
The third theory is to demonstrate the impacts from stock returns on FPI flows.
According to Ko et al (2005) who investigated the characteristics of the stock
ownership by institutional and foreign investors in both Japan and Korea, foreign
investors had more advantages in preferences to large capitalization and low bookto-market ratio stocks than institutional investors in both stock markets.
Furthermore, foreign investors prefered high-return stocks, especially in Korea.
Moreover, the preferred stocks of both institutional

and foreign investors had

statistically significant positive abnormal profits in both markets while favored ones
by either institutional or foreign investors had statistically significant positive
abnormal only in Korea. In other word, Liljeblom, E. and Loflund, A. (2005), who
investigated determinants of foreign equity investment flows after the deregulation
of Finnish stock market, indicated that the Finish stocks owned by foreigners were
found to deviate clearly from the Finnish stock market. Portfolios of foreign
investors were significantly titled to additional withholding tax on low dividendyield. Moreover, large- capitalization and liquidity stocks were preferred with a
record of strong profitability (measured by past ROI). Additionally, Thapa and
Poshakwale (2012), who found the answer for the question whether national equity
market characteristics explained specific differentiation in distribution of foreign
equity portfolios by using panel data of comprehensive foreign portfolio holdings
and different measures of national stock market factors for 36 host countries,
showed that foreign investors prefered larger and more visible developed markets
with higher liquidity, higher efficiency and lower transaction costs.

10


However, only a few studies like Froot et al (200 1) found a bilateral impact
,between FPI flows and stock returns. They studied the behavior of international
I

1

portfolio flows and their relationship with equity returns by employing panel data of
44 countries and found that international portfolio flows were strongly influenced
by past returns while foreign portfolio inflows had positive impact for future equity

returns. Moreover, the sensitivity of local stock prices to foreign inflows was
positive and large.
Based on the reality scenario in Vietnam, we support the theory about the unilateral
impacts from FPI flows on the VSM.

2.3.2 Conceptual framework.

Through theoretical frameworks, we can present the impact of FPI flows on stock
market as follows:

Stock market
(Delta-VN)

FPiflows

Test the impacts of FPI flows on Vietnam stock market
(Delta-VN) in the long-run and short-run
There has been the growing role of foreign portfolio investment in international
financial markets over the last decade. The increased flows to securities investment
from industrialized countries to emerging markets are able to lead to possibility for
development in all involved countries. The percentage of FPI holding in a stock is
an important factor to analyze. When this rate increases, the stock price goes up and
when it drops, the share price comes down. If foreign investors invest in a company,

11


jt is the good signal for this company's growth rate because they have seen the
potential growth in the recipient. However, in case, foreign holding rate is too large,

;;

tt means that this company's stock price is very volatile and risky because it's easier
for foreigners to move out of a stock. But no one can deny some positive impacts of
FPI on stock markets. First, foreign portfolio investors are professionals on stock
markets. So, they always purchase stocks on the basic of fundamentals. It means
that they require more information to evaluate. This leads to growing demands on
companies to become more transparent and more disclosure in order to be more
attractive to investors. Thus it helps reducing information asymmetric on stock
markets. Second, the globalization on stock markets require to reform securities
trading and transaction systems, nurture securities brokers and liquid markets.
Third, the stock markets' openness for FPI makes it more attractive to foreign
capital either direct or indirect flows. Fourth, FPI inflows boost financial innovation
'and development in trading instruments. Not only does it enhance competition in
financial markets but also improves the alignment of asset prices to fundamentals.
I

:However, the other side of the coin is that there are some dangers if certain limits
are exceeded. First, FPI flows are free and unpredictable. Moreover, foreign
investors always look for profits. When FPI flows move investments, they are likely
to cause severe price fluctuations resulting in risky volatility. Second, increased
holding rate from overseas may lead to loss of control in domestic firms. Third,
when FPI flows into stock market in huge amounts, they can create great influence
on the way the stock market behaves, going up or down. Fourth, the effect ofFPI on
the currency appreciation may lead to the un-competitiveness in the export
industries.
In this thesis, we aim to investigate the impacts of FPI flows on Vietnam Stock
Market (VSM) in the long run and the short run. Then, we make some
recommendations on policies for sustainable development in VSM to attract more
FPI flows.

12


2.4 Empirical studies.

i



Recently, there have been a lot of researches about the relationship between FPI
flows and stock returns. By applying various methods, most recent studies
demonstrated the complementary impact of FPI on stock returns.
Chakrabarti, R. (200 1) analyzed FII flows in India and their relationship with other
economic variables including stock returns by applying Granger Causality test on
monthly data from January 1993 to December 1999 of FII flows to India, market
capitalization data and other financial data like the exchange rate, short term interest
rate in India, return on the MSCI world index, S&P 500, BSE national index and
country credit rating data. He arrived the conclusions related to stock returns that
while the flows were closely related to Idian equity returns, they were effected by
these returns rather than the cause of that. Moreover, the Asian crisis marked a
regime change in the determinants of FII flows to Indian equity returns becoming
the sole driver of flows since the crisis. Moreover, when Fils were compared to the
local investors, they did not face an informational disadvantage in India.
On the other hand, Mukherjee et al (2002) used two types of variables to explore the
relationship of foreign institutional investment (FII) flows to the Indian equity
market with its possible covariates for the period January 1999 to May 2002. The
first included variables reflecting daily market return and its volatility in domestic
· and international equity markets. The second were macro variables affecting foreign
investors' expectation about return in Indian equity market like exchange rate,
short-term interest rate and index of industrial production (liP). The data-set was
combined with day-to-day variations, thus, it was suitable to test various
correlations, including Granger causality for equity market operations. After
relating daily FII flows, they modified the model specification to include the
variables' short-term past history over different time frames, like a week or
fortnight. Later, they tried to relate FII flows to Indian macroeconomic indicators.
Therefore, their results indicated that FII flows in the Indian equity market had

13


tendency to be caused by stock market returns but not vice versa. It meant that
Indian equity return was the most important factor affecting the FII flows into India.
Moreover, while FII sale and FII net inflows were strongly affected by Indian stock
market's performance, this market performance did not cause FII purchase. In other
words, FII investors did not diversify their investments by Indian stock market.
Also, returns from exchange rate differentiation and the Indian economic
performance might have affected on FII inflows , but such effects did not seem to
be strong. Finally, FII flows

were automatically daily correlated and this

correlation could not be calculated for the all.
In addition to the international evidences of the role of FPI on stock returns, there
are numerous evidences in a group of specific countries. Syriopoulos (20 10)
employed weekly stock index closing prices in the Balkan countries such as the
BET-C of Romania, SOFIX of Bulgaria, CROBEX of Croatia, ISE-1 00 of Turkey,
GR-GI of Greece, CYP-GI of Cyprus, S&P500 of the US and DAX of Germany
I

expanding from April 27, 1998 to September 10, 2007 to examine the risk and

:return of international portfolios allocated by investors to major Balkan equity
markets. They applied linear method like error-correction vector autoregressive
model and non-linear method like switching regime error correction model to test
for the potential linkages between Balkans and developed stock markets. The results
illustrated the presence of co-integration vectors indicating a stationary long-run
relationship among the Balkan equity markets. On the other hand, the Balkan equity
markets were affected by both domestic and external forces and shaped their longrun equilibrium path. However, inflows of international portfolio investments and
trading activity in the Balkan equity markets were growing rapidly.
Saxena and Bhadauriya (20 11) collected daily data series on Fils inflows and S&P
CNX NIFTY computed by logarithmic returns on daily closing prices for 7
financial years from April 2003 to March 2010 to explore the causal relationship
between FII inflows and volatility in indices of NSE by adopting unit root test,
Granger Causality test in a hi-variable VAR framework and vector auto regression.

14


For applying the test, they had to convert all variables into a stationary process
before including them into a VAR system. In order to test the variables' stationary,
they used Augmented Dickey Fuller test and Phillip Peron test. They aimed to find
the answer for the question that whether movements in Fil inflows had an effect on
stock market returns or movements in stock market returns had an effect on
direction of Fil inflows in India and got the results that there was no bidirectional
causal relationship between stock market volatility and Fil inflows. They found that
stock market volatility was a cause to foreign institutional investment inflows and
the trends of foreign institutional investment inflows did not have that much impact
on stock market volatility. Also, they found that the past data of stock market
returns could forecast the present and future trend of foreign institutional
investment inflows to India.
The most recent research is Kumar et al (2012) who studied empirically dynamic
interaction between Foreign Institutional Investor (Fil) flows and Indian stock
market returns through aggregate daily Fil data comprising three components
purchases, sales and net purchases along with the S&P CNX Nifty market index
taken by the log difference from 7th January 2000 to 61h August 2009 using ordinary
least square regression , vector auto regression and impulse response function along
. with Granger Causality test to illustrate a sharp and significant impacts between Fil
flows and Indian equity market returns. The results showed strong evidence of
. positive feedback trading of Fils with an adjusted R square of eleven percent. Also.
the Granger Causality test led to rejection of both null hypothesis lending strong
support to a bidirectional relation between Fils and equity market returns in India.
But, the overall response function of institutional investors to a one standard error
shock revealed a sharp and significant impacts dying out in four to five days.
2.5

Suggested research model

Theoretical framework shows that there are strong impacts from FPI flows on stock
returns. As a paper of Saxena and Bhadauriya (20 11) and Syriopoulos (20 10), we

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