Foreign Equity Flows Research Articles

Volatility and Foreign Equity Flows: Evidence from the Philippines

Purpose: To dissect the dynamic linkages between foreign equity flows, exchange rates and equity returns in the Philippines.Design/Methodology/Approach: Using a parsimonious SVARX-GARCH model and unique daily equity flow data this research models the relationship between net equity flows, conditional variance of stock returns, and conditional variance of exchange rates.Findings: The authors find several noteworthy results, which are unique to this study and several results that confirm existing literature. Much of existing literature on foreign equity flows into emerging economies find that foreign equity investors are trend chasers and equity flows are auto correlated. We confirm these finding in the Philippines. We also document two new and important findings. First, we find that unexpected increases in foreign equity flows to the Philippines increases the conditional volatility of the Filipino stock market significantly over the next two weeks of trading. Our second major finding is that unexpected shocks to foreign equity flows sharply increases the conditional variance of the USD/PHP exchange rate over the next two to three weeks of trading. Implications: Taken together our results indicate that foreign equity investment, while providing many benefits for small open economies such as the Philippines, does in the short run increase the conditional variance of both the equity market and exchange rates. Policy makers must weigh the benefits of increased risk sharing and the potential for lower costs of capital with the short-run potential for increase swings in asset prices.Originality: This paper is one of the only studies of its kind to test the impact of foreign equity flows on the conditional volatility of returns and exchange rates.

Foreign equity flows and the “Size Bias”: Evidence from an emerging stock market

This paper examines foreign investors' equity-level transactions in an emerging stock market, the Istanbul Stock Exchange, for the period 1997–2008 to derive insights into the debate on information asymmetries between domestic and foreign investors and the home bias puzzle. The analysis suggests two important findings. First, foreign investors do not consider the market portfolio of domestic securities as predicted by standard theories of international portfolio diversification. Second, the firm's size and the expected return are central to explain foreign investors' equity trades. The results are consistent with models based upon the hypothesis of differential information between foreign and domestic investors.

Returns or valuation? Foreign equity investment in the United States

PurposeThe purpose of this paper is twofold; first, to understand the long‐run dynamics between returns, valuation measures and foreign investment in the USA; second, to determine if these dynamics change following financial market upheaval.Design/methodology/approachTo address long‐run dynamic nature of the variables, multivariate autoregressive models are fitted for the period of January 1977 to November 2008. To gain additional insight about the nature of equity flows its dynamics are analyzed over the periods containing the 1987 stock market crash and the two major asset bubbles, e.g. internet bubble and the housing bubble.FindingsThe authors find that foreign institutional equity flows are more sensitive to innovations in valuation measures than innovations to excess US market returns; and that foreign investors increase their purchases of US market capitalization following a positive innovation to measures of valuation. The results imply that the behavior of foreign institutional investors are not described by “return chasing” alone. The authors further find that in times of increased uncertainty the joint dynamics between foreign equity flows and valuation measures decouples. Finally consistent with existing literature it was found that equity flows to the USA are autocorrelated.Originality/valueThere is a broad literature on the dynamics of US investment in emerging and developed markets, but very little (if any) research that analyzes the dynamics of equity flows to the US, returns, and measures of valuation. Furthermore, the literature on the behavior of equity flows surrounding financial crises is scant, particularly for developed markets.

Equity Prices and Equity Flows: Testing Theory of the Information-Efficiency Tradeoff

The paper tests three hypotheses concerning foreign equity investment in the presence of liquidity risk. First, the FDI-to-FPI price differential is negatively related to liquidity risk (the Price Discount Hypothesis). The idea is that market participants do not know whether the FDI investor liquidates a firm because of an idiosyncratic liquidity shock, or because, as an informed investor, the firm is hit by a productivity shock. Second, the FDI-to-FPI composition of foreign equity investment skews towards FPI if investors are expected to experience a liquidity shortage in the future (the Equity-Composition Hypothesis). The idea is that because direct investments are more costly to liquidate, due to the price discount, the more severe is the expected liquidity shock, the smaller is the FDI-to-FPI ratio. Third, the FDI-to-FPI composition of foreign equity flows skews towards FDI, the larger are past FDI-to-FPI stocks (the Strategic Complementarity Hypothesis). The idea is that high liquidity needs investors generate a positive information-externality for low liquidity needs investors among investors who choose FDI, and further increases in the number of FDI investors comes from mainly high liquidity needs investors. Such an increase reinforces the information externality, thereby lowering the FDI-to-FPI price discount, creating further incentives for investors to choose FDI. The paper brings these hypotheses to country level data consisting of a large set of developed and developing countries over the period 1970 to 2004. The evidence gives strong support to the hypotheses. To test the hypotheses, we apply also a dynamic panel model to examine the variation of FPI relative to FDI for source and host countries from 1985 to 2004. Country-wide sales of external assets are used as a proxy for liquidity problems. We estimate the determinants of liquidity problems, and then test the effect of expected liquidity problems on stock prices, the ratio of FPI to FDI and gross flows of FDI and FPI. We find strong support for the hypotheses: greater expected liquidity problems increase the price discount, have a significant positive effect on gross flows of FPI, negative effect on gross flows of FPI, and positive effect on the ratio between FPI and FDI.

Credit constraints, equity market liberalizations and international trade

This paper provides evidence that credit constraints are an important determinant of international trade flows. I exploit shocks to the availability of external finance and examine the impact of equity market liberalizations on the export behavior of 91 countries in the 1980–1997 period. I show that liberalizations increase exports disproportionately more in financially vulnerable sectors that require more outside finance or employ fewer collateralizable assets. This result is not driven by cross-country differences in factor endowments and is independent of simultaneous trade policy reforms. Moreover, it obtains with equal strength in the full panel of countries as well as in both panel and event-study analyses of countries which removed capital controls during the sample period. Finally, the effects of liberalizations are more pronounced in economies with initially less active stock markets, indicating that foreign equity flows may substitute for an underdeveloped domestic financial system. Similarly, opening equity markets has a greater impact in the presence of higher trade costs caused by restrictive trade policies.

An information-based trade off between foreign direct investment and foreign portfolio investment

The paper develops a model of foreign direct investments (FDI) and foreign portfolio investments (FPI). FDI enables the owner to obtain refined information about the firm. This superiority, relative to FPI, comes with a cost: a firm owned by the FDI investor has a low resale price because of asymmetric information between the owner and potential buyers. The model can explain several stylized facts regarding foreign equity flows, such as the larger ratio of FDI to FPI inflows in developing countries relative to developed countries, and the greater volatility of FDI net inflows relative to FPI net inflows.