Foreign Institutional Ownership and Stock Market Liquidity: Evidence from Indonesia
34 Pages Posted: 20 Mar 2008 Last revised: 15 Jan 2010
Date Written: January 1, 2008
From January 2002 to August 2007, foreign institutions held almost 70% of the free-float value of the Indonesian equity market, or 41% of the total market capitalization. Over the same period, liquidity on the Jakarta Stock Exchange improved substantially with spread more than halved and depth more than doubled. Was the high foreign institutional ownership a major contributing factor to the improvement? In this study we examine the Granger causality between foreign institutional ownership and liquidity. The direct and indirect effects of foreign institutions on liquidity measures are estimated using monthly Fama-McBeth regressions. We find that foreign preference for liquidity, though statistically significant, is economically small. However, their holdings have a negative impact on future liquidity: a 10% increase in foreign institutional ownership in the current month is associated with approximately 2% increase in the bid-ask spread, 3% decrease in depth, and 4% rise in price sensitivity in the next month. The liquidity effects of domestic institutions are mixed but more positive. The findings are consistent with the negative liquidity impact of institutional investors in developed markets, and challenge the view that foreign institutions enhance the liquidity in small emerging markets.
Keywords: foreign institutions, foreign ownership, liquidity, bid-ask spread, depth, price impact
JEL Classification: G14, G15, F36
Suggested Citation: Suggested Citation