Foreign portfolio investors before and during a crisis

Transcription

1 Journl of Interntionl Economics 56 (2002) locte/ econbse Foreign portfolio investors before nd during crisis b,c,d, * Woochn Kim, Shng-Jin Wei School of Public Policy nd Mngement, Kore Development Institute, Seoul, South Kore b Brookings Institution, Room 731, 1775 Msschusetts Ave., NW, Wshington, DC 20036, USA c Center for Interntionl Development, Hrvrd University, 79JFK Ave., Cmbridge, MA 02138, USA d NBER, 1050 Mss. Ave., Cmbridge, MA 02138, USA Received 1 Mrch 1999; received in revised form 12 June 2000; ccepted 5 September 2000 Abstrct Using unique dt set, we study the trding behvior of foreign portfolio investors in Kore before nd during the currency crisis. The centrl messge is tht investors in different ctegories hve different trding ptterns. For exmple, foreign investors outside Kore re more likely to engge in positive feedbck trding strtegies nd re more likely to engge in herding thn the brnches/ subsidiries of foreign institutions in Kore or foreign individuls living in Kore. This difference in trding behvior is possibly relted to the difference in their informtion. This pper suggests tht it my be worth exploring policies tht cn encourge foreign investors to cquire more informtion (e.g. by setting up brnch or subsidiry in the emerging country) Elsevier Science B.V. All rights reserved. Keywords: Foreign portfolio investment; Crisis; Feedbck trding; Herding JEL clssifiction: F21; F3; G15 1. Introduction This pper is bout the behvior of interntionl portfolio investors in emerging mrkets. Such knowledge is highly relevnt to the literture on finncil/ currency *Corresponding uthor. Tel.: ; fx: E-mil ddress: swei@brook.edu (S.-J. Wei) / 02/ $ see front mtter 2002 Elsevier Science B.V. All rights reserved. PII: S (01)00109-X

2 78 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) crises in developing countries nd to the debte on the desirbility of cpitl controls. In the context of the recent Asin finncil crisis, it hs been lleged tht foreign portfolio investors my hve been positive feedbck trders (e.g. rushing to buy when the mrket is booming nd rushing to sell when the mrket is declining), nd eger to mimic ech other s behvior while ignoring informtion bout the fundmentls. Behviors such s these could hve excerbted the crisis to n extent not otherwise wrrnted by economic fundmentls. The hypothesis cn be connected with n emerging literture on behviorl finnce, mostly in the domestic finnce context. For exmple, it hs been rgued tht individul investors trding is often driven by irrtionl, sentimentl shocks (for exmple, see Lee et l., 1990, 1991, for n explntion of the discounts on the closed-end funds). As nother exmple, gin using evidence from domestic mrket dt, it hs been rgued tht institutionl investors often exhibit herding behvior, though the tendency is quntittively smll (see Lkonishok et l., 1992). There re lso theoreticl models in which the existence of noise trders induces rtionl investors to pursue positive feedbck strtegies, destbilizing the prices in the process (De Long et l., 1990). In this pper, we provide n ccount of the behvior of foreign portfolio investors using cse study of Kore before nd during its currency crisis tht strted in lte Our project is possible due to unique dt set. It detils monthly positions of every foreign investor in every stock on the Koren Stock Exchnge (both First nd Second Sections) from December 1996 to June We cn seprte investment mde by individuls from those mde by institutions. Moreover, we cn distinguish subsidiries or brnches of foreign institutions in Kore or individuls living in Kore from those who invest purely from brod. This distinction is importnt s one my expect tht those who invest from New York nd London re informtionlly disdvntged reltive to those tht hve physicl presence in the emerging mrket. Informtion symmetry is one of the cuses of concern bout foreign investors. Differences in informtion my led to differences in behvior. Thus, our bility to seprte these foreign investors in the dt is very useful. Using dt on ggregte US equity investment in foreign mrkets, Bohn nd Tesr (1996) exmined the reltive importnce of return-chsing nd portfolio reblncing motivtions. Regressing net purchse in mrket on the forecst of the return on the mrket, they find positive nd significnt coefficient, nd conclude tht return-chsing is importnt. The pper does not exmine firm- or investor level dt. Frnkel nd Schmukler (1996, 1998) hve exmined n importnt spect of portfolio investment in emerging mrkets, nmely, possible informtionl symmetry between domestic nd interntionl investors. But their dt set (prices of closed-end country funds nd their corresponding net sset vlues) does not llow them to distinguish between institutionl versus individul investors, or to investigte possible momentum trding or herding behvior. Bsed on survey of (mostly mnufcturing) firms sponsored by the World Economic Forum, Kufmn et l. (1999) reported evidence tht mngers of firms pper to hve informtion

3 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) on the likelihood of currency crisis in their countries. Using dt on US mutul funds tht specilize in Ltin Americn countries, Kminsky et l. (1999) exmined the tendencies tht fund mngers nd fund customers my engge in momentum trding. They lso investigted the tendencies tht mutul fund s trding behvior is ffected by stock movement in nother mrket. Choe et l. (1999) use trnsction dt on the Koren stock mrket (December, 1996 to December, 1997) to exmine the effect of foreign investor trding on the Koren stock price. They find evidence of foreign investors engging in positive feedbck trding nd herding, but the evidence becomes weker or insignificnt in the lst 3 months of their smple. Becuse our pper lso studies the Koren cse, it my be useful to highlight some importnt differences between the two ppers. First, while we hve dis-ggregted informtion on positions by different foreign investors, they hve ggregte positions by foreign investors s block. Thus, in their pper, to compute the herding mesures, ech buy- or sell-trde hs to be ssumed to originte from seprte investor. As they cknowledged, this ssumption could induce upwrd bis in the computed herding sttistics since the sme investor could hve executed multiple trdes (likely in the sme direction) in given period of time. In our smple, s every investor s position is identified by unique ID number, we do not hve to mke this ssumption, nd cn presumbly obtin more ccurte herding sttistics. Second, our dt llows us to exmine possible differences in behvior by different types of investors. Indeed, we find some systemtic nd importnt differences between non-resident foreign investors nd brnches or subsidiries of foreign institutions in Kore. Third, our dt extends to June, 1998, llowing for better comprison of the trding behvior before nd during the crisis. For exmple, in contrst to their finding, we find firly strong evidence of continued herding nd positive feedbck trding during the crisis. The pper is orgnized s follows. Section 2 describes our dt sets. Sections 3 nd 4 exmine the two spects of foreign investor behvior, respectively: feedbck trding nd herding. Section 5 offers some concluding remrks. 2. Dt We mke use of two dt sets in this pper. We first describe the dt, nd then explin how foreign investors re clssified into different ctegories, nd how the smple is broken down into different sub-periods Investor position dt For ech investor, identified by n ID code, this dt set contins mong others things, the following informtion,: (i) month-end shre holding for ech stock listed in the Kore Stock Exchnge (KSE), (ii) ntionlity, (iii) residence, (iv) type

4 80 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) (e.g. individul or institutionl), nd (v) whether the investment ceiling is binding or not for tht investor in tht month. For confidentility resons, only the codes but not the nmes of the investors re vilble. The dt set ws kindly provided by the Kore Securities Computer Corportion (KOSCOM), n ffilite to the Kore Stock Exchnge (KSE), under the condition tht the dis-ggregted position informtion will not be reveled to ny unuthorized third prty. It is generlly rre to hve detiled dt on positions by seprte foreign investors nd by seprte stocks in emerging mrkets. In our cse, the Koren government s restriction on foreign ownership of domestic stocks nd its 1 need to enforce the restriction help to mke this dt vilble. All foreign investors re required to register in their rel nmes with the Koren Securities Supervisory Bord (KSSB), with penlties for violtions violtors will hve 2 their registrtion suspended nd be brred from investing in Kore for two yers Stock dt For ech stock, we collect informtion on (i) month-end price, (ii) month-end number of shres outstnding, (iii) monthly trnsction volume (nd vlue), nd (iv) whether the investment ceiling is binding or not in tht month. In ddition, we lso collect informtion on the Kore Composite Stock Price Index (KOSPI) from the KSE nd month-end Won/ dollr exchnge rte from the Federl Reserve Bord s website. 1 For exmple, between My nd November 1997, foreign investors, in ggregte, could not own more thn 23% of the outstnding shres per compny nd foreign investors, individully, could not own more thn 6%. Since My 1998, such generic restrictions on foreign ownership hve been removed. However, for shres on two firms, Pohng Iron & Steel Co., or POSCO, nd Kore Electric Power Co., or KEPCO, there is 30% upper limit on foreign ownership on public interest grounds (bsed on the Securities Trnsction Act). Some industry-specific lws my impose limits on foreign ownership on dditionl firms. The generic restrictions on foreign ownership hve evolved over time s follows. The upper ceiling for foreign investors collectively strted with 10% (Jn. 1992), nd chnged to 12% (Dec. 1994) 15% (Jul. 1995) 18% (Apr. 1996) 20% (Oct. 1996) 23% (My 1997) 26% (Nov. 1997) 55% (Dec. 1997), nd eventully to 100% (My 1998). As for individul foreign investor, the upper ceiling chnged from 3% (Jn. 1992) 4% (Apr. 1996) 5% (Oct. 1996) 6% (My 1997) 7% (Nov. 1997) 50% (Dec. 1997) 100% (My 1998). Source: Finncil Supervisory Service (2000), pge 1. 2 An unfortunte omission in our dt set is informtion on ADRs or GDRs on Koren compnies. In our smple, there re 24 compnies tht hve issued GDRs nd ADRs. The simple sum of the cpitl rised through ADRs nd GDRs by June 98 ws pproximtely US$5 billion, which ccounted for less thn 5% of the totl mrket cpitliztion of the Koren mrket t the time. We re not wre of ny dt source tht would llow us to know the positions on the GDRs/ADRs by individul foreign investors nd mtch up with our dt set. This problem is lso present in other ppers in the literture such s Choe et l. (1999). We would speculte, however, tht the holders of the ADRs nd GDRs my not be the sme set of investors tht invest directly in the Koren mrket. Note lso tht the firms tht hve issued ADRs nd GDRs tend to be big nd re more likely to run up ginst the foreign ownership limit. All observtions (stocks months) tht hve reched such limit re excluded in our subsequent sttisticl nlyses.

5 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) Fig. 1. Exchnge rte level (US$ per 1,000 Koren won). Figs. 1 nd 2 plot the exchnge rte (US dollr/1000 Won) nd the stock mrket price index (KOSPI), respectively. Combining the two pieces of informtion, Fig. 3 trces the dollr vlue of $100 investment in KOSPI on Jnury 1, 1997 throughout the smple (to June 30, 1998) Clssifiction of foreign investors We clssify ll foreign investors in our smple into four ctegories (Tble 1): () Resident institutionl investors subsidiries or brnches of foreign 3 institutions tht re registered in Kore; (b) Non-resident institutionl investors foreign institutionl investors not in ctegory (); Fig. 2. Stock price index (KOSPI, ). 3 Note tht there is reltively smll number of investors in the ctegory of resident institutions. So it my be more difficult to generlize the inferences bsed on this group of investors.

6 82 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) Fig. 3. Current vlue of US$100 investment in KOSPI mde on Jnury 1, (c) Resident individul investors non-koren ntionls who live in Kore; (d) Non-resident individul investors non-koren ntionls not in ctegory (c) Clssifiction of the sub-periods The dt set spns from December 1996 to June We brek our smple into three sub-periods: Tble 1 Summry informtion on foreign portfolio investors in Kore All foreign investors Residents Non-residents No. of Averge No. of Averge No. of Averge investors position investors position investors position US$1000 US$1000 US$1000 All foreign Dec. 27, ,594 5, ,065 7,029 investors Nov. 29, ,202 3, ,675 3,870 Individuls Dec. 27, Nov. 29, Institutions Dec. 27, ,859 7, ,001 1,833 7,894 Nov. 29, ,486 4, ,928 1,460 4,428 Notes: (1) This tble only reflects investors who registered t the Kore Securities Supervisory Bord (KSSB) before December 31, 1996 nd who re portfolio investors. (2) Resident foreign individul investors re non-koren ntionls who live in Kore. Resident foreign institutionl investors re Koren brnches or subsidiries of foreign institutions. Non-resident foreign individul or institutionl investors re those who invest from outside Kore. (3) Number of investors clculted by the number of unique investor ID codes. (4) Between the two dtes (Dec. 27, 1996 nd Nov. 29, 1997), mrket cpitliztion fell by 50% in US dollr terms, while verge positions of resident individuls, non-resident individuls, nd non-resident institutions fell by 51, 60, nd 44%, respectively. Contrry to other investors, verge position of resident institutions rose by 48%.

7 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) () December 1996 My 1997, trnquil period. This ws the time when Kore ws regrded s one of the mircle economies in Est Asi, nd foreign investors were enthusistic bout investing in Kore. (b) June 1997 October 1997, pre-currency crisis period. While Kore s own currency crisis would come lter in November of tht yer, the currency of Thilnd, Bht (nd mybe other currencies in Asi) ws under severl specultive ttcks in June. The Thi Bht collpsed t the beginning of July, mrking the beginning of wht we now cll the Asin finncil crisis. The Thi crisis sent repercussions throughout the region. The Koren stock mrket lso strted its slide in June nd continued more or less during the period. (c) November 1997 June 1998, in-crisis period. On November 18, the Bnk of Kore gve up defending the Koren Won. On November 21, the Koren government sked the IMF for bil-out. The crisis begn in November 1997 nd continued beyond the end of our smple. There were lso some instnces of lbor unrest nd mjor bnkruptcies during the period. 3. Momentum trding We now exmine whether foreign investors engge in so-clled positive feedbck ( positive momentum or just momentum ) trding strtegy. Positive feedbck trding strtegy is one with which n investor buys pst winners nd sells pst losers. In contrst, negtive feedbck (or contrrin) trding strtegy does the reverse: buying pst losers nd selling pst winners. Positive feedbck trding could destbilize the mrket by moving sset prices wy from the fundmentls. This trding pttern cn result from extrpoltive expecttions bout prices, from stop-loss orders utomticlly selling when the price flls below certin point, from forced liquidtions when n investor is unble to meet her mrgin clls, or from portfolio insurnce investment strtegy which clls for selling stocks when the price flls nd buying it when the price rises. At lest since Friedmn (1953), mny economists believe tht positive feedbck trders cnnot be importnt in mrket equilibrium s they re likely to lose money on verge. This view hs been chllenged in the lst decde or so. De Long et l. (1990) rgued tht in the presence of noise trders, even rtionl investors my wnt to engge in positive feedbck trding, nd in the process destbilize the mrket. To exmine whether investors engge in positive feedbck trding, we need to mesure the connection between their trding on prticulr stocks nd the prior performnce of the stocks. Following metric proposed in Grinbltt et l. (1995) nd modified by Kminsky et l. (1999), we dopt the following mesure of momentum trding for investor group k: F G Q(k, j,t) 2 Q(k, j,t 2 1) M(k, j,t) 5 ]]]]]] R( j,t 2 1) (1) Q *(k, j,t)

8 84 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) where Q(k, j,t) is the number of shres of stock j held by investor (or investor group) k t time t, Q *(k, j,t) is the verge of Q(k, j,t) nd Q(k, j,t21), nd R( j,t21) is the return on stock j from t22 tot21. The momentum mesure for prticulr investor (or investor group) k over given smple period is: 1 M(k) 5] OO M(k, j,t) (2) JT t j where J is the totl number of stocks trded by k, nd T is the totl number of time periods under considertion. Under the null of no feedbck trding (in either direction), the men vlue of M(k) is zero. Furthermore, M(k) is symptoticlly norml (s J nd T pproch infinity). If there is systemtic positive feedbck trding, then M(k) would be positive. On the other hnd, if there is systemtic negtive feedbck trding, then 4 M(k) would be negtive. To void possible bises in quntifying the trding behvior, we exclude certin observtions (investors or stock month). First, investors who declre their purpose of the stock purchse s direct investment re excluded becuse they do not engge in ctive trding. Second, investors who re registered fter December 31, 1996 re dropped becuse their entrnce to the mrket could show up only s buy. Third, stocks tht hve reched foreign ownership limit re dropped becuse ny chnge in the net position of the foreign investors s whole hs to be sell to Koren investors. Fourth, observtions (stock month) involving stocks not initilly owned by ny foreign investors re lso excluded. Since short-selling ws not permitted, ny chnge in positions would hve to be buy. The lst three criteri re ment to minimize possible bises in computed momentum. We report the bsic mesures of momentum trding for ech ctegory of investors in Tble 2. There re few prominent fetures in the tble. First, for resident foreign investors, there is no sttisticlly significnt evidence tht they engge in either positive or negtive feedbck trding in ny sub-period (except in one cse institutionl investors in the pre-crisis period). Second, in contrst to resident foreign investors in the two sub-periods before the Koren currency crisis, non-resident foreign investors disply significnt tendency to engge in positive feedbck trding, regrdless of whether they re individuls or institutions. Third, once the currency crisis broke out, the non-resident institutions incresed their intensity of positive feedbck trding (from mesure of 0.47 during 4 Our dt does not llow us to exmine portfolio reblncing effect. Portfolio reblncing normlly clls for selling ppreciting stocks nd buying depreciting stocks, the opposite of positive feedbck trding. So the presence of portfolio reblncing effect would imply tht positive feedbck trding my be stronger thn our sttistic suggests (but negtive feedbck trding my be weker).

9 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) Tble 2 Momentum trding (1) (2) (3) Resident Non-Resident 5(2)2(1) Trnquil (1) Individul ** 0.157*** period (0.036) (0.046) (0.058) [5,523] [3,230] (2) Institution ** (0.135) (0.022) (0.136) [1,676] [39,703] (3)5(2)2(1) (0.139) (0.051) Pre-crisis (4) Individul *** 0.165*** period (0.022) (0.045) (0.050) [6,841] [3,758] (5) Institution 0.303** 0.471*** (0.128) (0.021) (0.130) [2,845] [48,084] (6)5(5)2(4) 0.300** 0.303*** (0.130) (0.050) In-crisis period (7) Individul (0.059) (0.097) (0.113) [10,749] [5,506] (8) Institution *** 1.232*** (0.322) (0.060) (0.327) [2,910] [67,165] (9)5(8)2(7) *** (0.327) (0.114) Notes: (1) Ech cell in columns 1 nd 2, nd rows 1, 2, 4, 5, 7 nd 8, reports the momentum mesure mesured by M(k, j,t) 5 [hq(k, j,t) 2 Q(k, j,t 2 1)j/Q *(k, j,t)] 3 R( j,t 2 1) where Q(k, j,t) is number of shres held by investorkon stockjt month t; Q *(k, j,t) is n verge of Q(k, j,t) nd Q(k, j,t 2 1). Ech cell reports momentum mesure in percentge terms. (2) R( j,t 2 1) ; lnp( j,t 2 1) 2 ln P( j,t 2 2), wherep( j,t) is price of stock j t month t (in locl currency). (3) Stndrd errors re in the prentheses nd number of observtions re in the brcket. ***, **, nd * denote significnce levels t the 1, 5, nd 10% levels, respectively. (4) Trnquil period: December 1996 My 1997; Pre-crisis period: June October 1997; In-crisis period: November 1997 June June October, 1997, to mesure of 0.88 fter November, 1997). On the other hnd, individul investors from brod disply some evidence of switching to negtive feedbck trding strtegy. While their momentum mesure tkes negtive coefficient, it is not significnt t the 10% level (or mrginlly significnt t the 15% level). The results reported in Tble 2 re bsed on definition of returns in the locl currency (Koren won). One my rgue tht interntionl investors my cre more bout returns tht tke into ccount the exchnge rte movement, which ws big during the currency crisis period. The winners in terms of the Koren won could

10 86 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) be losers in terms of the US dollr. However, it is worthwhile to note tht for given foreign investor in given period, the sme exchnge rte chnge would be pplied to the returns on ll Koren stocks. In ny cse, we report in Tble 3 different set of momentum mesures tht tke into ccount exchnge rte movement in the return clcultion. We cn see tht Tble 3 is qulittively similr to Tble 2, with few differences. It is useful to note tht economic reforms tht generlly improve the stock returns in country cn occur simultneously s the country liberlizes its policies 5 on cpitl inflows. In this cse, in terms of time-series properties, foreign cpitl inflows cn pper to follow rise in (mrket-wide) stock returns. It is useful to note tht in this pper, we look t trding ptterns s function of the reltive Tble 3 Momentum trding (djusting for exchnge rte chnges) (1) (2) (3) Resident Non-Resident 5(2)2(1) Trnquil (1) Individul *** 0.198*** period (0.037) (0.052) (0.064) [5,523] [3,230] (2) Institution *** (0.136) (0.023) (0.138) [1,676] [39,703] (3)5(2)2(1) * (0.141) (0.057) Pre-crisis (4) Individul *** 0.176*** period (0.023) (0.047) (0.052) [6,841] [3,758] (5) Institution 0.316** 0.513*** (0.132) (0.022) (0.134) [2,845] [48,084] (6)5(5)2(4) 0.314** 0.336*** (0.134) (0.052) In-crisis period (7) Individul ** (0.064) (0.108) (0.125) [10,749] [5,506] (8) Institution *** 0.945*** (0.358) (0.059) (0.363) [2,910] [67,165] (9)5(8)2(7) *** (0.363) (0.123) Notes: See footnotes to Tble 2. The returns re in US dollrs. 5 See Bekert nd Hrvey (1998) nd Henry (2000) for evidence on n increse in return fter liberliztion, nd Bekert et l. (2000) for evidence for n increse in foreign portfolio inflows following liberliztion.

11 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) returns cross stocks within common mrket. So the correltion between current trding nd pst returns is unlikely to be generted by mrket-wide events. It is lso useful to check if the positive-feedbck trding strtegy in our smple is ex post profitble. We perform this check by compring the ctul performnce of the positive nd negtive feedbck trding strtegies. We focus on the group of non-resident institutions to reduce the influence of investor type. Using technique proposed by Grinbltt nd Titmn (1993), we djust for risk by compring the returns of the new nd the old portfolios of the investor. In other words, the risk levels on the new nd the old portfolios re ssumed to be similr so tht the return on the new portfolio in excess of the old is nturlly djusted for its risk level. We proceed in two steps. First, we clssify ll the investor month pirs into two ctegories, positive versus negtive feedbck trders, depending on whether n investor s momentum mesure, M, is positive or negtive in given month. Second, for ech ctegory, we compute the following risk-djusted returns, verged over ll trders in the sme group: F 1 Q(k, j,t) 2 Q(k, j,t 2 1) Performnce(n) 5]] OOO ]]]]]] R( j,t 1 n) (3) KJT Q *(k, j,t) k j t G where K, J, nd T re number of investors in the group, number of stocks, nd number of months in the period, respectively. Lower cse n in Performnce(n) nd R( j,t1n) denotes return horizon. For exmple, R( j,t11) nd R( j,t13) re the returns for stock j over 1- nd 3-month horizons, respectively. Under the ssumption tht the systemtic risks for the old nd new portfolios re (pproximtely) the sme, Performnce(1) nd Performnce(3) mesure the risk- 6 djusted return for the new portfolio over 1 nd 3 month horizons, respectively. Tble 4 reports the ex post profitbility clcultions for the two trding strtegies. We find tht during both the trnquil nd the crisis period, positive feedbck trding genertes negtive risk-djusted returns wheres contrrin trding genertes positive risk-djusted returns. The differences in the returns between the contrrin nd positive feedbck trding strtegies re significnt t both the 1- nd 3-month horizons. Moreover, the gp is widened during the crisis period. The exception is the pre-crisis period when the reverse is true: positive feedbck trding is profitble but the negtive feedbck trding loses money. To summrize, except for 6-month (pre-crisis) period in our 19-month smple, the contrrin trding strtegy ppers to dominte the positive feedbck trding in terms of ex post risk-djusted profitbility. 6 Grinbltt nd Titmn (1993) provide some evidence tht the bets re the sme for the two portfolios in their smple.

12 88 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) Tble 4 Ex post profitbility of the momentum trding strtegies (non-resident institutions) (1) (2) (3) Momentum trders Contrrin trders 5(2)2(1) Trnquil Momentum 6.156*** *** period (0.233) (0.251) [9,613] [2,028] 1-Month *** 0.792*** 0.965*** return (0.067) (0.199) (0.210) [9,613] [2,028] 3-Month ** return (0.113) (0.339) (0.357) [9,612] [2,028] Pre-crisis Momentum 6.862*** *** period (0.127) (0.106) [6,065] [4,430] 1-Month 6.485*** *** *** return (0.251) (0.203) (0.323) [6,062] [4,430] 3-Month 4.606*** *** return (0.571) (0.548) (0.792) [6,056] [4,427] In-crisis period Momentum *** *** (0.318) (0.398) [7,761] [6,259] 1-Month *** 1.010*** 9.763*** return (0.858) (0.274) (0.901) [7,761] [6,259] 3-Month *** 1.767*** *** return (1.021) (0.545) (1.157) [7,761] [6,259] Notes: (1) Note tht investors re divided into groups: (Positive) momentum trder group includes those observtions with M.0; nd the contrrin group includes those with M,0. (2) N-months ex-post performnce is mesured by: PN(k, j,t) 5 [hq(k, j,t) 2 Q(k, j,t)j/q(k, j,t)] 3 hln P( j,t) 2 ln P( j,t)j, where P( j,t 1 n) is price of stock j t month t 1 n. n 5 1 nd 3. Ech cell reports ex-post performnce mesure in percentge terms. (3) Also see footnotes to Tble Herding We now turn to exmining nother populrly lleged behvior by foreign investors herding. This is the tendency for investors of prticulr group to mimic ech other s trding. Informtionl symmetry my cuse uninformed but rtionl specultors to choose to trde in the sme wy s informed trders (Bikhchndni et l., 1992; Bnerjee, 1992). Since informtionl problems my be

13 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) more serious when it comes to investing in foreign mrket thn the domestic one, herding my be correspondingly more severe. There is n lterntive explntion for herding mong institutionl investors. Unlike individul investors, fund mngers fce regulr reviews (e.g. qurterly for mutul funds, nd nnully for pension funds) on their performnce reltive to benchmrk nd/or to ech other. This my induce them to mimic ech other s trding to greter extent thn they otherwise would (see Schrfstein nd Stein, 1990). There hve been severl empiricl ppers tht quntify herding behvior. Lkonishok et l. (1992), Grinbltt et l. (1995), Wylie (1997), nd Wermers (1999) ll report evidence of herding mong US or UK institutionl investors, though not lrge in mgnitude. Using dt on foreign investors (or US investors) in Kore s single group, Choe et l. (1999) find evidence of herding. None of the previous ppers tht we re wre of compres different herding tendencies by different investor types on dt from single source. None of the ppers tht we know of differentites the informtionl symmetry versus regulr performnce review hypotheses. We believe tht heterogeneity mong investors in our smple llows us to test for the reltive importnce of the competing hypotheses by exploring their different implictions. The logic of informtionl symmetry hypothesis suggests two ptterns: (i) Individul investors my herd more thn the institutions s the ltter hs more resources to ssemble nd process informtion bout foreign mrket. (ii) Non-resident investors my herd more thn resident foreign investors ssuming the ltter hve more timely informtion bout the country they live in. On the other hnd, the logic of regulr performnce review hypothesis hs different predictions: (i) Institutionl investors my herd more thn individul investors since the ltter do not fce regulr performnce reviews. (ii) There my not be ny difference between resident nd non-resident foreign investors, ssuming the two fce the sme performnce reviews. We will interpret our findings in light of these predictions. We employ the herding indices proposed by LSV (1992) but construct the smple in wy tht tkes into ccount the Wylie (1997) correction for possible bis induced by short-selling constrint. Let B(i, j,t) be the number of investors in group i tht hve incresed the holdings of stock j in month t (i.e. number of net buyers), nd S(i, j,t) the number of investors in group i tht hve decresed the holdings of stock j in month t (number of net sellers). Let p(i,t) be the number of net buyers in group i ggregted cross ll stocks in month t divided by the totl number of ctive trders (number of net buyers plus number of net sellers) in group i ggregted cross ll stocks in month t. Then, H(i, j,t) is defined s the herding index for investors in group i, on stock j, in month t: U U U U ]]]]] B(i, j,t) ]]]]] B(i, j,t) H(i, j,t) 5 2 p(i,t) 2 E 2 p(i,t) (4) B(i, j,t) 1 S(i, j,t) B(i, j,t) 1 S(i, j,t)

14 90 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) N O B(i, j,t) j51 N N O B(i, j,t) 1O S(i, j,t) j51 j51 p(i,t) 5]]]]]]] (5) N 1 H(i,t) 5] O H(i, j,t) (6) N j51 T N 1 H(i) 5] OOH(i, j,t) (7) NT t51 j51 H(i,t) is the herding index for group i in month t, verged cross ll stocks. H(i) is the herding index for group i, verged cross ll months in the smple. In the definition of H(i, j,t), is subtrcted to mke sure tht the resulting index is insensitive to generl mrket conditions (i.e. bull or ber mrket). By tking bsolute vlues, the first term in Eq. (4) cptures how much of the investment is polrized in the direction of either buying or selling. The second term in Eq. (4), lso clled the djustment fctor, is subtrcted to correct for the men vlue of the 7 first term under the ssumption of no herding. The second term cn be computed under the ssumption tht follows binomil distribution. Note tht for lrge N nd T, nd follow norml distributions by the centrl limit theorem. To void ny possible bis in computing the herding indices, we exclude certin investors nd observtions (stock month) from our smple. Like the smple we hve constructed to exmine positive feedbck trding, we exclude here: (i) investors tht re registered fter December 31, 1996, (ii) investors who buy stocks for direct investment purpose, (iii) stock months for which the foreign ownership limit is reched, nd (iv) stock months for which the stocks re not owned by foreign investors in the previous month. The lst exclusion is motivted by the short-selling constrint. When short selling is not llowed, ny trde on tht stock would hve to first show up s buy, thus bising the herding index upwrd (Wylie, 1997). Finlly, if stock in given month is trded by only one foreign investor in tht group, tht observtion is dropped. The bsic results re presented in Tble 5. For ech investor group i nd ech sub-period, we report the corresponding herding sttistics, H(i), with stndrd errors in the prentheses below. Then we perform sequence of difference-inmen tests between individul nd institutionl investors (reported in rows 3, 6, nd 9), nd between non-resident nd resident investors of ny given group (reported in column 3). A number of ptterns stnd out. First, except for the Koren subsidiries/ 7 Also, the djustment fctor, the second term in Eq. (4), is decresing function of the number of trders ctive, [B(i,t) 1 S(i,t)].

15 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) Tble 5 Herding (1) (2) (3) Resident Non-Resident 5(2)2(1) Trnquil (1) Individul 7.102*** *** 6.139* period (2.136) (2.571) (3.343) [81] [58] (2) Institution *** 4.810*** (1.520) (0.455) (1.587) [103] [1,195] (3)5(2)2(1) ** *** (2.622) (2.611) Pre-crisis (4) Individul 8.301** *** period (3.338) (3.071) (4.535) [41] [43] (5) Institution *** 7.035*** (1.548) (0.487) (1.622) [163] [1,140] (6)5(5)2(4) *** ** (3.679) (3.109) In-crisis period (7) Individul 4.848** 8.422*** (2.093) (2.160) (3.007) [57] [92] (8) Institution *** (1.487) (0.401) (1.540) [139] [1,523] (9)5(8)2(7) *** (2.568) (2.197) Notes: U U U U ]]]] B( j,t) ]]]] B( j,t) H( j,t) 5 2p(t) 2 E 2 p(t) B( j,t) 1 S( j,t) B( j,t) 1 S( j,t) J O B( j,t) j51 p(t) ;]]]]] J J O B( j,t) 1O S( j,t) j51 j51 where B( j,t) is number of buyers on stock j t month t; S( j,t) is number of sellers on stock j t month t; nd Jis the totl number of stocks listed in the exchnge. Ech cell reports herding mesure in percentge terms. brnches of foreign institutions, ll other three ctegories of foreign investors hve engged in sttisticlly significnt herding. This is true in ech of three subperiods. Second, bsed on the point estimtes, foreign investors outside Kore (the non-resident individuls or institutions) lwys herd more thn their counterprt

16 92 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) inside Kore in ech of the three sub-periods. The vlues of the herding sttistic for the non-resident foreign investors re often twice s high s resident foreign investors. In hlf of the cses, the differences re sttisticlly significnt. Third, individul investors lwys herd more thn institutions. The herding mesure for the individuls is generlly twice s big s or more thn tht for institutionl investors. In five out of the six cses, the difference is sttisticlly significnt. These ptterns re consistent with the theory tht herding is induced by informtionl symmetry. At the sme time, the contrst between institutionl investors (who re subject to regulr reltive performnce evlutions) nd individuls (who re not) suggests tht the incentive to herd driven by the reltive performnce review considertions is probbly not the dominnt feture of the dt. Herding indices essentilly mesure the degree of correltion in trding behviors mong investors in given group. As such, they do not by themselves distinguish between two possibilities: tht investors intentionlly mimic ech other s trding, versus tht investors respond to common informtion bout the fundmentls. To distinguish between the two is difficult. We cn provide some suggestive evidence here by exmining ex post profitbility of the herding behvior in our smple. If the high vlues of herding sttistics in our smple simply reflect the fct tht the investors re responding to common informtion nd tht this informtion is return-relevnt, then, we would expect tht those stocks tht the investors herd to buy should yield positive bnorml returns (reltive to those stocks they do not herd s much), nd those stocks tht they herd to sell should yield negtive bnorml returns. Our strtegy is to exmine the following. For ech investor group nd ech time period, we link the ex post return on prticulr stock j, djusted for its risk level, with mesure of the degree of herding on tht stock. We djust for risk on both sides of the regressions. On the left-hnd-side, we construct n ex post profitbility mesure of trding in stock j from t21 tot nd hold it for n months, reltive to the profitbility tht would hve been ttined if the previous month s position were to continue: 1 Q(k, j,t) 2 Q(k, j,t 2 1) Performnce( j,t,n) 5] OF]]]]]] GR( j,t 1 n) (8) K Q *(k, j,t) k * As before, Q(k, j,t) is investor k s position in stock j t time t, Q (k, j,t) isthe verge of Q(k, j,t) nd Q(k, j,t 2 1), nd R( j,t 1 n) is the return on stock j if held from month t to month t1n. On the right-hnd-side of the regressions, we include time nd industry dummies to control for mrket-wide nd industry-wide risk fctors. In ddition, we crete buying-herding dummy to indicte when the herding is on the buying side:

17 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) D( j,t) 5 1ifB( j,t)/[b( j,t) 1 S( j,t)]. p(t) (9) As for the herding sttistics, B( j,t) nd S( j,t) re the numbers of buyers nd sellers of stock j t time t, respectively; nd p(t) is the verge tendency to buy t time t cross ll stocks for tht investor group. We cn use [1 2 D( j,t)] to denote selling-herding. We run the following type of regressions: Performnce( j,t,n) 5 constnt, time dummies, industry dummies, 1 b1d( j,t) H( j,t) 1 b 2[1 2 D( j,t)] H( j,t) 1 e( j,t) (10) If stocks tht investors herd to buy or herd to sell generte bnorml returns ex post, we would expect b 1.0 nd b 2,0. We perform such regression for every investor group (e.g. non-resident institutions) in every sub-period (e.g. trnquil period) for both 1- nd 3-month horizons. The results for the 1-month horizon re reported in the top pnel of Tble 6. Among the 24 coefficients reported, ten of them re sttisticlly significnt. However, of these ten, three hve the correct sign, nd seven hve the wrong sign. In other words, herding is more often on the wrong side thn not. In the remining 14 cses, (risk-djusted) returns from herding is essentilly not different from rndomly picking stocks to buy or sell. To summrize the results differently, there is no single group of investors tht hs profited consistently from herding in ll three sub-periods, nor is there subperiod in which ll groups of investors hve profited from herding. Hence, overll, t the 1-month horizon, herding does not pper to generte systemtic ex post profits for the foreign investors. The lower pnel of Tble 6 computes risk-djusted returns if the investors were to hold their stocks for 3 months. We hve lso computed ex post profitbility in US dollr terms (i.e. the exchnge rte movement is incorported into the profitbility clcultions. However, this tble is not reported in order to sve spce). In both cses, the qulittive fetures re very similr to the top pnel of Tble 6. Thus, we conclude tht whtever motivtes the herding behvior in our smple, it does not pper to generte systemtic ex post bnorml returns. 5. Concluding remrks In this pper, we provide n ccount of foreign investors trding behvior in the Kore Stock Exchnge (KSE) during the period December 1996 June The unique dt set in the pper detils every foreign investor s monthly stock positions. An importnt finding of the pper is tht heterogeneity mong foreign investors mtters. Lumping them together would give misleding pictures. For exmple, the Koren brnches/ subsidies of foreign institutions or foreign individul investors

18 94 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) Tble 6 Ex post profitbility of herding Residents Non-Residents 2 2 Herd-buy Herd-sell R Herd-buy Herd-sell R b1 b2 b1 b2 One-month investment horizon Trnquil Individuls period (0.217) (0.034) [67] (0.066) (0.044) [50] Institutions 0.321* 0.083* * (0.191) (0.043) [93] (0.013) (0.006) [1,152] Pre-crisis Individuls ** period (0.916) (0.107) [33] (0.221) (0.083) [34] Institutions * *** 0.040*** 0.19 (0.034) (0.058) [156] (0.017) (0.012) [1,109] In-crisis period Individuls * ** (0.879) (0.202) [46] (0.209) (0.073) [83] Institutions *** (0.731) (0.366) [132] (0.064) (0.045) [1,489] Three-months investment horizon Trnquil Individuls period (0.520) ( [66] (0.119) (0.079) [50] Institutions *** * (0.752) (0.167) [93] (0.021) (0.011) [1,152] Pre-crisis Individuls * 0.241* 0.67 period (1.515) (0.178) [33] (0.357) (0.134) [34] Institutions *** 0.503*** *** 0.147** 0.21 (0.102) (0.172) [156] (0.045) (0.030) [1,109] In-crisis period Individuls (0.431) (0.099) [46] (0.494) (0.172) [83] Institutions *** 0.090* 0.08 (0.855) (0.428) [132] (0.075) (0.052) [1,489] Notes: (1) PN( j,t,n) 5 1 ind 1 t 1 b1d( j,t) H( j,t) 1 b 2[1 2 D( j,t)] H( j,t) 1 e jt, where PN( j,t,n) is computed by tking n verge of PN(k, j,t) over investor k; constnt; ind n industry dummy; t yer month dummy; H( j,t) herding mesure of stock j t month t; nd n51 nd 3. (2) D( j,t) 5 1ifB( j,t)/[b( j,t) 1 S( j,t)]. P(t) nd 0 if otherwise. (3) Stndrd errors re in the prentheses nd numbers of observtions re in the brckets. ***, **, nd * denote significnce levels t 1, 5, nd 10% levels, respectively. living in Kore re less likely to engge in positive feedbck trding nd less likely to engge in herding thn their non-resident counterprts. We note tht foreign investors in our smple were smll prt of the overll Koren mrket (their positions were bout 15% of the mrket cpitliztion). In prt becuse of their size, their trding is unlikely to hve hd big impct on the prices (Choe et l., 1999). However, s more nd more emerging mrkets re

19 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) mde more open to interntionl investors, their impct could increse. Even in Kore, dditionl openness of the cpitl ccount nd the equity mrket hs tken plce since the end of our smple. The trding pttern by the foreign investors s reveled in this pper, if confirmed by future studies from other emerging mrkets, could potentilly trnslte into more mrket instbility in the developing countries. If one is to consider controls on foreign cpitl inflows, one re tht hs not received much ttention is policies tht my encourge foreign investors to cquire more informtion bout the emerging mrket (e.g., by setting up subsidiry or brnch in the country). This pper suggests tht it my be worth exploring. Acknowledgements We thnk Chul-Hee Prk t the Kore Securities Computer Corportion (KOSCOM) for kindly providing the investor position nd stock dt sets, Rick Imi, Mike Kennedy, Richrd Zeckhuser, seminr prticipnts t the OECD, University of Cliforni Dvis, Hrvrd University, nd University of Mrylnd, three referees nd the co-editor (Velsco) for helpful comments, nd Greg Dorchk for editoril ssistnce. Prt of the pper ws written when Shng-Jin Wei ws visiting the OECD. The views in the pper re the uthors own, nd my not be shred by ny orgniztion they re or hve been ssocited with. References Bnerjee, A., A simple model of herd behvior. Qurterly Journl of Economics 107, Bekert, G., Hrvey, C., Cpitl Flows nd the Behvior of Emerging Mrket Equity Returns, NBER Working Pper No Bekert, G., Hrvey, C., Lumsdine, R., The Dynmics of Emerging Mrket Equity Flows, NBER Working Pper No Bikhchndni, S., Hirshleifer, D., Welch, I., A theory of fds, fshion, custom, nd culturl chnge s informtion cscdes. Journl of Politicl Economy 100, Bohn, H., Tesr, L.L., US equity investment in foreign mrkets: portfolio reblncing or return chsing? Americn Economic Review 86, Choe, H., Kho, B.-C., Stulz, R.M., Do foreign investors destbilize stock mrkets? The koren experience in Journl of Finncil Economics 54, Finncil Supervisory Service, Foreign Portfolio Investment Finncil Supervisory Service, Seoul, Republic of Kore, In Koren. Frnkel, J.A., Schmukler, S.L., Country Fund Discounts, Asymmetric Informtion nd the Mexicn Crisis of 1994: Did Locl Residents Turn Pessimistic Before Interntionl Investors, NBER Working Pper No Frnkel, J.A., Schmukler, S.L., Country Funds nd Asymmetric Informtion, World Bnk Policy Reserch Working Pper No Friedmn, M., The cse for flexible exchnge rtes. In: Friedmn, M. (Ed.), Essys in Positive Economics. University of Chicgo Press, Chicgo, IL.

20 96 W. Kim, S.-J. Wei / Journl of Interntionl Economics 56 (2002) Grinbltt, M., Titmn, S., Performnce mesurement without benchmrks: n exmintion of mutul fund returns. Journl of Business 66, Grinbltt, M., Titmn, S., Wermers, R., Momentum investment strtegies, portfolio performnce, nd herding: study of mutul fund behvior. Americn Economic Review 85, Henry, P., Stock mrket liberliztion, economic reform, nd emerging mrket equity prices. Journl of Finnce 55, Kminsky, G., Lyons, R., Schmukler, S., Mngers, Investors, nd Crises: Mutul Fund Strtegies in Emerging Mrkets, World Bnk Policy Reserch Working Pper No Kufmn, D., Mehrez, G., Schmukler, S., Predicting Currency Fluctutions nd Crises: Do Resident Firms Hve n Informtionl Advntge, World Bnk Policy Reserch Working Ppers No Lkonishok, J., Shleifer, A., Vishny, R., The impct of institutionl trding on stock prices. Journl of Finncil Economics 32, Lee, C.M.C., Shleifer, A., Thler, R., Anomlies: closed-end mutul funds. Journl of Economic Perspectives 4, Lee, C.M.C., Shleifer, A., Thler, R., Investor sentiment nd the closed-end fund puzzle. Journl of Finnce 46, De Long, J.B., Shleifer, A., Summers, L.H., Wldmnn, R.J., Positive feedbck investment strtegies nd destbilizing rtionl specultion. Journl of Finnce 45, Schrfstein, D.S., Stein, J.C., Herd behvior nd investment. Americn Economic Review 80, Wermers, R., Mutul fund herding nd the impct on stock prices. Journl of Finnce 54, Wylie, S., Tests of the Accurcy of Mesures of Herding. Unpublished Pper.