Do Local Individual Investors Learn from Foreign Fund Flows?

Abstract:     
We investigate imitative herding and its effects on asset prices by examining how individual investors respond to a noisy signal regarding the positions of traders who they believe may possess valuable private information. We exploit a natural experiment in the Thai equity market, where a regulatory change resulted in the public dissemination of information about foreign institutional investors' aggregate daily flows on a stock-by-stock basis. We find that local individual investors' order imbalances increase in the first hour of trading following the release of information indicating that foreign investors were net purchasers of a stock on the previous day. Stock prices also appear to adjust quickly, and we find no evidence of subsequent reversal. Consistent with such price adjustments, the profitability of trading by foreign investors declines significantly after the transparency change. The results are consistent with a rational model of imitative herding in which the cost of adoption increases as more individuals imitate, preventing herd behavior from having a destabilizing effect on prices.

Number of Pages in PDF File: 41

Keywords: transparency, herding, information cascade, information transmission

JEL Classification: G12, G14, G15

working papers series