In recent years, the study of causality between mutual funds investment flow and stock market returns has attracted the attention of researchers and academicians world over. But the existing empirical evidence on this issue is rather mixed. Furthermore, there exist a few studies that include the case of India. Thus, this article is an attempt to investigate the dynamics of the relationship between mutual funds investment flow and stock market returns in India for the period January 2000 to May 2010. The application of Toda and Yamamoto approach to the Granger causality tests provides the evidence of unidirectional causality running from the stock market returns to mutual funds investment flow. This indicates that in India increase in stock market activities attract the mutual funds to the capital market. And, hence, necessary steps should be taken by the government as well as monetary authorities to make the capital market less volatile and more efficient.
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