Investment and Capital Market Imperfections: Some Evidence from a Developing Economy, India

This paper presents a switching regression model of investment decision where the probability of a firm facing financial constraint is endogenously determined. The approach, therefore, obviates the use of a priori criteria to exogenously identify the financially constrained firms, and thereby addresses the potential misclassification problem faced in the existing literature. A sample of 576 Indian manufacturing firms, collected across 15 broad industries is used for this study. The study establishes that financially constrained firms exhibit a much higher investment-cash flow sensitivity than those identified to be unconstrained. It also probes into the possible determinants of financial constraints, and finds empirical support for its hypothesis that young, liquidity constrained and low dividend payout firms are more likely to face financial constraints, when compared to their respective counterparts. This paper also provides some insight into the impact of the ongoing liberalization program on the financial constraints faced by the Indian firms.Investment, capital market imperfection, financial constraints, emerging economy, India

Dynamics of the impact of currency fluctuations on stock markets in India: Assessing the pricing of exchange rate risks

This paper studies the dynamics of the impact of currency fluctuation on Indian stock market by assessing the pricing of exchange rate risk during the period 2005–2016, specifically before and after financial crises. Estimating a two-factor arbitrage pricing model, using a random coefficient model, the paper presents evidence that stock returns react significantly to foreign exchange rate fluctuations in the post-crisis period. Particularly, during the last four years of our sample, 2012–2016, the exchange rate risk factor is becoming a prominent determinant of stock returns, indicating that Indian investors are increasingly expecting a risk premium on their investment for their added exposure to exchange rate risk. This is also further corroborated by the study by highlighting the fact that higher the foreign exchange exposure of industry, measured by trade balance (net inflows), higher is their sensitivity to exchange rate risk (βS). A plausible reason for such premium could be the inadequate hedging by Indian firms to mitigate the exchange rate risk. Keywords: Exchange rate risk, Arbitrage pricing theory, Stock returns, Risk premium, Hedging, Financial crisis, JEL classification: G01, G11, G12, G3

Size, age and firm growth in the Indian manufacturing sector

The conventional wisdom on the relationship of firm growth with its size and age is typically based on the studies in developed economies. In contrast, this study analyses the firm growth patterns for an emerging economy, namely India. It uses a balanced panel of 392 manufacturing firms over the years 1989–1990 to 1992–1993 to explore unobserved heterogeneity among firms. Results indicate that age positively influences growth, which is the opposite of the result obtained in previous studies. The current size negatively impacts growth as in earlier studies. Results also indicate that smaller and older firms grow faster than their counterparts. Size effect is larger in food industry while the age effect is larger in non-metal industry.