Do Foreign Institutions Improve Stock Liquidity?

45 Pages Posted: 21 Mar 2010 Last revised: 26 Nov 2010

See all articles by Chishen Wei

Chishen Wei

Hong Kong Polytechnic University - School of Accounting and Finance

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

Wei, Chishen, Do Foreign Institutions Improve Stock Liquidity? (November 23, 2010). Available at SSRN: https://ssrn.com/abstract=1571220 or http://dx.doi.org/10.2139/ssrn.1571220

Chishen Wei (Contact Author)

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong