Factor Exposures of Foreign Equity Capital in a Domestic Stock Market: Evidence from Korea
International Review of Finance, 2016
Posted: 10 Jan 2015 Last revised: 16 Aug 2017
Date Written: November 11, 2016
In this paper, we examine the factor exposures of foreign equity capital in a domestic stock market in order to understand its risk-taking behavior and sources of returns in the market. Using data from Korea for the 1999-2013 period, we find that foreigners are strongly exposed to the idiosyncratic volatility (IVOL) factor, which is long on low-IVOL stocks and short on high-IVOL stocks. That is, foreign equity capital is typically allocated to low-IVOL stocks and profits from the return differential between low- and high-IVOL stocks. We also find that foreign equity capital moves in a way that it is loaded more on the IVOL factor when the IVOL factor premium is larger. We discuss the comparative advantage of foreign equity capital in bearing the IVOL factor risk and the role of information asymmetry between locals and foreigners in this risk sharing. We also provide additional empirical results that support our interpretation.
Keywords: Foreign investors, Factor loadings, Idiosyncratic volatility, Korea
JEL Classification: F30, G11, G15
Suggested Citation: Suggested Citation