Abstract:
This study examines the long-term interaction between investor behaviour and market
performance in Sri Lanka, a representative frontier market marked by moderate
liquidity and macroeconomic fluctuations. Using monthly data from 1994 to 2024,
investor transactions are categorised by type and origin, including purchases and sales
by foreign companies, foreign individuals, local companies, and local individuals.
Johansen cointegration and Vector Error Correction Models (VECM) are applied to
assess whether these investor groups influence or respond to long-run market
dynamics. The results indicate that while overall market movements, proxied by the
All Share Price Index (ASPI), significantly affect all investor categories in the short
term, only sales by local individuals play a leading role in long-run equilibrium
adjustments. In contrast, foreign investors exhibit reactive behaviour, responding to
rather than anticipating market shifts. These findings question the assumed
informational advantage of foreign investors in frontier settings and underscore the
critical role of local retail sentiment in price formation. Policy implications include
enhancing investor education and managing retail-driven volatility.
