Market Efficiency and Foreign Institutional Trading: Evidence from the Taiwan Futures Market

Abstract

The literature frequently views foreign institution investors in emerging markets as informed traders with an information advantage that likely increases market efficiency. Using a unique data set from the Taiwan Futures Exchange (TAIFEX), we directly investigate the informational role played by foreign institution investors. Interestingly, we find that, despite a significant increase in foreign institution trading over the past few years, liquidity costs increased significantly and the informational efficiency of market price actually deteriorated. We find direct evidence showing that the increase in foreign institutional trading is associated with the deterioration of market efficiency. We reconcile this unexpected finding by showing that foreign institution investors are more likely to act as market makers on the TAIFEX by submitting passive limit orders.

Keywords: Foreign institution, Market efficiency, Liquidity cost, Limit order, Order aggressiveness

JEL Classification: G12, G14