1. Introduction

The abolition of ownership restrictions, applied to the listed companies held by non-residents in Korea Stock Exchange (KSE), reached the completion stage in May 1998. Along with liberalization of capital movement, the measure has steadily encouraged non-resident foreign investors into increasing investment activities in the KSE so that the proportion of foreign ownership measured in market capitalization is estimated to exceed 40% at the end of 2004.

Many pros and cons are brought up on increases in foreign ownership in the listed companies. Advocates for extensive foreign ownership emphasize the beneficial effects of transparency, shareholder-oriented management and improved corporate governance stimulated by foreign ownership. On the other hand, many skeptics argue that most of the foreign investors active in the Korean stock market are international speculators pursuing short-term capital gains and having no interest in the long-term viability of the companies. This paper does not intend to take sides in the controversy, but aims to provide some solid empirical facts on the investment behavior of foreign investors and to infer the economic implications of the empirical findings. Specifically, we examine the existence of herding and positive feedback trading among foreign investors. Herding indicates collective buying or selling among a particular group of investors in excess of overall market trends and positive feedback trading means buying the winners, that is, shares that showed good past performance and selling the poor performers. Neither herding nor positive feedback trading implies irrationality of investors by itself. The main reason we are interested in these kinds of behavior is that they could result in undesirable consequences on market stability under certain circumstances.

2. Synopsis

This paper utilizes transactions and quotes (TAQ) data files provided by the KSE to measure herding and positive feedback trading by foreign investors. TAQ files provide us with a unique research opportunity in that they contain all the details of orders submitted and transactions executed on the KSE. We do not claim that the paper is the first body of research to investigate herding and positive feedback trading by foreign investors in the Korean stock market. We were able to find at least two preceding examples of research examining the same topics with TAQ files. However, they focused on the window period around the foreign exchange crisis in 1997. It would be very interesting to investigate the changes, if at all, in the investment behavior of foreign investors in recent years as they by all means play a major role in the Korean stock market.

We found little or extremely weak evidence of herding by foreign investors. The result is at odds with the findings in previous research concentrating on the occasion of the crisis in 1997. Though one can guess that increases in trading activities and ownership of foreign investors may accompany changes in the composition of investors and their investment strategy to bring about the differences, we should wait for further research for a more plausible explanation. A cautionary note should be added that we should not extrapolate the result to claim that a significant shock to the market, such as the crisis in 1997, would not provoke fierce herding behavior among foreign investors. Though not statistically meaningful, we found higher degrees of herding among shares with a large market capitalization, and higher sensitivity to overall market changes. Widening the length of the observational window from day to week, month, and quarter also results in stronger herding patterns.
We found limited evidence of positive feedback trading by foreign investors. The tendency was a little more conspicuous in shares with lower volatility and smaller trading volumes.

3. Conclusion

The findings in this paper should not be cited as evidence for or against the destabilizing role of foreign investors in the Korean stock market. Here is the conclusion we can draw from the analysis; considering the measures we take in the analysis such as the H-index and D-index, we cannot find sufficient evidence to reject the null hypothesis that foreign investors do not do harm to market stability.

발간사

요 약

제1장 서 론

제2장 외국인의 주식시장 진출 확대

　제1절 외국인의 주식 소유 한도 규제
　제2절 외국인 주식 거래 추이
　제3절 외국인 주식 소유 증가와 관련된 이슈

제3장 실증 분석

　제1절 군집행동
　　1. 군집행동에 대한 경제적 해석과 선행 연구
　　2. 군집행동의 측정: 방법론과 자료
　　3. 분석결과
　제2절 시세추종 거래
　　1. 시세추종 거래의 개념과 선행 연구
　　2. 시세추종 거래의 측정
　　3. 실증분석결과

제4장 결 론

참고문헌

<부 록> 산업별, 외국인 순매수 기준 H-지수