Do Foreign Institutions Improve Stock Liquidity?
45 Pages Posted: 21 Mar 2010 Last revised: 26 Nov 2010
Date Written: November 23, 2010
Abstract
This paper examines whether capital flows by foreign institutions improve liquidity in domestic markets. I find that stocks with increased foreign institutional ownership subsequently experience higher liquidity. However, it is difficult to interpret this evidence as a causal relation because institutions tend to self-select into more liquid stocks. To solve this problem, I exploit the 2003 US dividend tax cut as a natural experiment. The results from a 2SLS (IV) regression confirm that liquidity improved more in dividend-paying stocks located in US tax-treaty countries compared to similar stocks located in non-treaty countries. These patterns are consistent with the notion that institutions improve liquidity through a variety of channels including information competition and greater liquidity trading.
Keywords: Institutional Investors, Foreign Investors, Liquidity
JEL Classification: F30, F36, G20, G15
Suggested Citation: Suggested Citation
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