A note on foreigners’ trading and price effects across firms

• Published in: Journal of banking & finance Vol. 28; no. 3; pp. 615 - 632
• Main Authors: Dahlquist, Magnus, Robertsson, Göran
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.03.2004; Elsevier; Elsevier Sequoia S.A
• Series: Journal of Banking & Finance
• Subjects: Banking; Capital; Capital costs; Correlation analysis; Cost of equity capital; Costs; Equity; Equity capital; Feedback trading; Finance; Foreign investment; Investment policy; Investments; Liberalization; Momentum; Portfolio flows; Portfolio management; Prices; Rates of return; Securities markets; Studies; Trade; Feedback trading; G11; G12; Momentum; G15; G14; Cost of equity capital; Portfolio flows
• ISSN: 0378-4266; 1872-6372
• DOI: 10.1016/S0378-4266(03)00036-0

We study the investment behavior of foreign investors in association with an equity market liberalization, and find a strong link between foreigners’ trading and local market returns. In the period following the liberalization, net purchases by foreign investors induced a permanent increase in stock prices, suggesting that local firms reduced their cost of equity capital. We also find a strong link between a firm’s fraction of foreign ownership and the magnitude of the cost reduction. Foreign investors seem to prefer large and well-known firms, and these firms realize the largest reduction in capital cost. Furthermore, our analysis suggests that foreigners increase their net holding in firms that have recently performed well. Analyzing foreigners’ performance, we find very little evidence of informed trading, suggesting that risk sharing is the most plausible explanation for the reduction of the cost of equity capital.