Foreign investor behaviour and the Asian financial crisis

Abstract

This study's objective is to identify the relative importance of local and foreign investor expectations in explaining the short-run behaviour of equity returns in Asian markets during a period encompassing the 1997 financial crisis. The analysis utilises the insight that the pricing behaviour of closed-end country funds (CEFCs) in relation to their constituent underlying assets, can be used as a mechanism for distinguishing between the relative impact of local and foreign investor expectations. To ensure robust results, the analysis incorporates several different empirical specifications (error correction models, multivariate VAR and single equation), and uses alternative measures of underlying asset prices in the Asia markets. The results suggest that both local and foreign investor expectations are important as a channel determining the pricing behaviour of Asian assets trading in Asian and US equity markets. This finding appears independent of the degree to which a specific Asian equity market is open to foreign investment. Moreover, the measured impact of country-specific foreign investor information is enhanced during periods of financial crisis. The findings lend credibility to the view that the trading behaviour of foreign investors was significant in sustaining the dimension and duration of the Asian crisis.