The Liability of Foreignness in International Equity Investments

Download or read book The Liability of Foreignness in International Equity Investments written by Bok Baik and published by . This book was released on 2013 with total page 44 pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.