Abstract
This study discusses the trading behavior of foreign investors with respect to economic uncertainty in the South Korean stock market from a time-varying perspective. We employ a news-based measure of economic uncertainty along with the model of time-varying parameter vector autoregression with stochastic volatility. The empirical analysis reveals several new findings about foreign investors’ trading behaviors. First, we find evidence that positive feedback trading often appears during periods of high economic uncertainty, whereas negative feedback trading is exclusively observable during periods of low economic uncertainty. Second, the foreign investors’ feedback trading appears mostly to be well-timed and often leads the time-varying economic uncertainty except in periods of global crises. Third, lagged negative (positive) response of net flows to economic uncertainty is found to be coupled with lagged positive (negative) feedback trading. Fourth, the study documents an asymmetric response of foreign investors with regard to negative and positive shocks of economic uncertainty. Specifically, we find that they instantly turn to positive feedback trading after a negative contemporaneous response of net flows to shocks of economic uncertainty. In contrast, they move slowly toward negative feedback trading after a positive response of net flows to uncertainty shocks.
Highlights
The liberalization of financial markets in emerging economies sparked significant international capital movements, most of which have been short-term portfolio investments and instruments
The net flow-return relationship and the trading behaviors of foreign investors have been extensively studied, with attention mostly focused on stock markets of advanced and emerging economies
We investigate the interactions between foreign investors and stock returns with respect to economic uncertainty in the South Korean stock market from a time-Varying perspective
Summary
The liberalization of financial markets in emerging economies sparked significant international capital movements, most of which have been short-term portfolio investments and instruments In this regard, foreign investors have often been perceived as highly influencing in terms of stock prices in these markets and, their trading behaviors were of interest to policymakers and many academic researchers. Some studies contrasted this finding and provided evidence on foreign investors’ outperformance of their domestic counterparts (e.g., Grinblatt and Keloharju 2000; Froot and Ramadorai 2008) In light of these results, Albuquerque et al.’s (2009) global private information model argues that positive feedback trading is not a symptom of inferior knowledge at a domestic level, but it is due to the foreign investors’ superior information at a global level
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