How Foreign Investors Influence Stock Markets? The Saudi Arabian Experience

Abstract

This paper investigates the impact of foreign institutional investors on valuation, liquidity and volatility in Saudi stock exchange for the pre- and post-period from November 10, 2014 to June 12, 2015 and from June 15, 2015 to January 22, 2016 respectively, utilizing daily market trade data. Saudi regulators allowed foreign investment community to invest in Tadawul (i.e., Saudi stock exchange). The paper finds significant decline in prices of stocks in the post-liberalization period, suggesting that foreign traders aid in price discovery process and bringing the prices back to their fundamental values. In contrast to the policy makers’ intention and empirical evidence, the liquidity decreases and bid-ask spreads widen. These results imply that domestic individual investors engage in non-fundamental trading in the past, avoid trading against sophisticated foreign investors in the presence of heightened asymmetric information risk during the post-liberalization period.

Keywords: Foreign institutional investors, Asset pricing, Feedback trading, Saudi stock exchange, Regulation

JEL Classification: G12, G15, G18