The Liability of Foreignness in International Equity Investments: Evidence from the U.S. Stock Market

44 Pages Posted: 2 Mar 2013

See all articles by Bok Baik

Bok Baik

Seoul National University

Jun-Koo Kang

Nanyang Technological University (NTU) - Nanyang Business School

Jin-Mo Kim

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Joonho Lee

California State Polytechnic University, Pomona - Accounting Department

Date Written: February 20, 2013

Abstract

Using foreign institutional ownership data in the U.S. from 1990 to 2007, we examine whether foreign institutional investors face liabilities of foreignness (LOF) in the U.S. stock market. We find that foreign institutional investors prefer low information asymmetry stocks more than domestic institutional investors and this preference for low information asymmetry stocks is particularly strong among foreign institutional investors from countries with high LOF. More important, we find that a change in foreign institutional ownership is negatively related to future returns, while this relation does not exist for domestic institutional ownership. The negative relation between the change in foreign institutional ownership and future returns is more pronounced when investors face a greater LOF in the U.S. stock market, for instance, when they are from countries with higher institutional distance, information asymmetry, unfamiliarity, and cultural differences. The negative effect of country-specific LOF factors on the return forecasting power of foreign institutional investors is more evident when they trade stocks with higher information asymmetry. Overall, these findings suggest that foreign institutional investors face significant LOF costs in the U.S. stock market, resulting in their poor ability to forecast returns.

Keywords: foreign institutional ownership, domestic institutional ownership, liability of foreignness, return predictability, information asymmetry

JEL Classification: G12, G14, G15, F21

Suggested Citation

Baik, Bok and Kang, Jun-Koo and Kim, Jin-Mo and Lee, Joonho, The Liability of Foreignness in International Equity Investments: Evidence from the U.S. Stock Market (February 20, 2013). Available at SSRN: https://ssrn.com/abstract=2226890 or http://dx.doi.org/10.2139/ssrn.2226890

Bok Baik

Seoul National University ( email )

Seoul
Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

Jun-Koo Kang

Nanyang Technological University (NTU) - Nanyang Business School ( email )

Nanyang Avenue, Block S3-01b-54
Singapore, 639798
Singapore
(+65) 6790-5662 (Phone)
(+65) 6791-3697 (Fax)

HOME PAGE: http://www.nbs.ntu.edu.sg/nbs_corporate/divisions/bnf/index.asp

Jin-Mo Kim (Contact Author)

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

Janice H. Levin Bldg., Room 121
94 Rockafeller Road
Piscataway, NJ 08854-8054
United States

Joonho Lee

California State Polytechnic University, Pomona - Accounting Department ( email )

College of Business Administration
Pomona, CA 91768
United States
9098694597 (Phone)

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