Information and Management Sciences

Volume 19, Number 2, pp. 315-328, 2008

Foreigner Investors and Stock Volatility:

Evidence from Taiwan
Chia-Jui Lai

Kuo-Ren Lou

Dahan Institute of Technology

Tamkang University

R.O.C.

R.O.C.
Cheng-Yi Shiu

National Central University

R.O.C.
Abstract
Financial authorities in many emerging markets often view foreign investors as enemies
because foreign investors tend to cause excess volatilities and thus destabilize local markets.
This paper studies the impact of foreign investors trade on stock volatility in Taiwans stock
market. We collect daily foreign trade and stock return and turnover data at firm level
from January 2000 to September 2006. Sample covers 20 firms of highest foreign ownership
in Taiwan Stock Exchange. We employ the GJR-GARCH model to examine the impact
of foreign trade on conditional volatility. The advantage of the GJR-GRACH model is its
ability to capture asymmetric effects of good and bad news on conditional volatility. We find
that foreigners trade has a positive relation on concurrent return, and the trade of foreign
investors increases conditional volatility. However, we argue that foreign investors play the
role of price discovery by trading local stocks. When the prices of local stocks deviate from
intrinsic value, foreign investors trade to push price back to equilibrium. Foreign investors
improve the market efficiency by trading local stocks, accompanied by the facts that price
adjustment increases local stock volatilities.

Keywords: Foreign Investors, Volatilities, GARCH Model.

1. Introduction
The impact of foreign traders on local stock markets is an important issue for the governments of emerging markets and academics and practitioners ever since the openness
and globalization of emerging markets. The previous literature has been often discussed
but also has conflicting results on the impact of foreign investors.
Received October 2006; Revised January 2007; Accepted March 2007.
Supported in part by National Science Council, Taiwan, R.O.C. under the grant NSC95-2416-H-008040.

316

Information and Management Sciences, Vol. 19, No. 2, June, 2008

Kaminsky, Lyons, and Schmukler (2001, 2004) investigate the trading strategies
of equity mutual funds in emerging stock markets. They conclude that mutual funds
from foreign countries follow momentum strategies and herd. That is, foreign mutual
funds tend to buy stocks when the market is booming and to sell when the market
is declining, and foreign mutual funds are eager to mimic each others behavior while
ignoring information about the fundamentals. During crisis, mutual funds are more
inclined to sell stocks whose prices have fallen, and sell stocks from one country when
asset prices fall in another country. The momentum strategies, herding, and contagion
trading have exacerbated the crisis to the extent far beyond explained by the economic
fundamentals, and therefore, foreign investors are blamed for the financial crisis. Kim
and Wei (2002) examine the trading behavior of foreign investors in Korea before and
during the currency crisis. They also find that foreign investors outside Korea are more
likely to follow momentum strategies and are more likely to engage in herding behaviors.
Hamao and Mei (2001) have a similar findings in Japanese stock market.
In contrast, literature such as Choe, Kho, and Stulz (1999), Kim and Singal (2000),
and Miles (2002) have a different view on the impact of foreign investors trade on stock
volatility. Choe, Kho, and Stulz (1999) argue that although foreign investors engage
in positive feedback trading and herding before the Korean Financial Crisis in 1997,
foreign investors reversely follow the negative feedback trading strategies during the
financial crisis period. Kim and Singal (2000) and Miles (2002) investigate the impact
of emerging stock markets openness to foreign investors on stock price behaviors. Their
findings demonstrate that the allowance of foreign investors to trade stocks in emerging
markets does not increase the stock market volatility.
The role of foreign investors in emerging stock market is essential especially for the
debate on foreign investment flow control during the financial crisis period. To shed
light on this issue, this study goes further step to directly examine the impact of foreign
investors trade on stock volatility. The data of foreign trade is daily data at individual
firm level. This unique dataset enables us to test the core issue that whether the foreign
investors trade increases stock return volatilities or not.
We choose top 20 highest foreign ownership firms in Taiwan Stock Exchange, as
based on data of the end December 2005, as a sample in this study. For each sample firm, daily foreign trade and stock return and turnover data from January 2000 to
September 2006 are collected. We employ the GJR-GARCH model to examine the impact of foreign trade on conditional volatility. The advantage of GJR-GRACH model,

Foreigner Investors and Stock Volatility: Evidence from Taiwan

317

similar to Threshold GARCH model, is its ability to capture different effects of good and
bad news on conditional volatility.
We briefly introduce our main results. We find that foreigners trade not only has a
positive relation on concurrent return but also increases conditional volatility. Because
foreigners trade has a predictive for future returns, we argue that foreign investors play
the role of price discovery by trading local stocks. When the prices of local stocks deviate
from intrinsic value, foreign investors trade to push price back to equilibrium. Foreign
investors improve the market efficiency by trading local stocks. The more volatile of stock
returns is accompanied by the price adjustments. This higher volatility is the product
of the market efficiency improvement by foreign investors trade.
The rest of this paper is organized as follows. In Section 2 we introduce our data. In
Section 3 we show the empirical methodology. Section 4 presents the empirical results
and discussions. Conclusions are in Section 5.
2. Data
2.1. History and structure of Taiwan Stock Exchange
The Taiwan Stock Exchange (TSEC) began operations in 1962. Although only 18
companies were listed in 1962, this figure increased to 691 by the end of December 2005.
Taiwans stock market had a market capitalization of NT$15.6 trillion (New Taiwan Dollars), equal to approximately US$489 billion, and stock trading value of NT$18.8 trillion,
with an annual turnover of 127% in 2005. The total market capitalization is 140.83% of
GDP in Taiwan economy. These statistics show that TSEC is a very important emerging
stock market for global investment.
Taiwan opened its stock market in 1983 by allowing domestic investment trust companies to raise overseas funds for investment in the local market. In 1991, Qualified
Foreign Institutional Investors (QFIIs) were allowed to invest directly in the local stock
market. QFIIs must obtain permission from both the Securities and Futures Commission
(SFC) and the Central Bank.1 The investment quota for each QFII was originally US$50
million, and it gradually increased to US$600 million by 1996 and US$3 billion by the
end of 2001. Furthermore, direct investment by individual foreign investors has been
allowed since 1996. The original investment quota was US$5 million for foreign individual investors and US$20 million for foreign institutional investors; the latter figure was
1 Since October 1997, any foreign investors who invest less than US$50 million may apply directly to the SFC,
without approval of the Central Bank.

318

Information and Management Sciences, Vol. 19, No. 2, June, 2008

gradually increased to US$50 million. On September 30, 2003, Regulations Governing

Investment in Securities by Overseas Chinese and Foreign Nationals was amended and
the QFII system was abolished. After that, all foreign investors can invest in the securities market after simply registering with the TSEC. The maximum investment quota
for foreign investors is abolished as well.
A QFII can normally invest in listed shares, government bonds, corporate bonds,
and money market instruments. Trading of local futures for hedging and investment
in convertible bonds were permitted in July 1998 and March 2000, respectively. The
ceilings for each foreign investors holdings in individual listed firms was originally set
at 5% in 1991, and gradually increased to 10% in 1996, and 50% in 1999. The ceiling
for total foreign investments was 10% in 1991, gradually increasing to 20% in 1996, and
50% in 1999. The holding ceilings for each foreign investors holding in individual firms
and for total foreign investment were removed on December 30, 2000.
2.2. Foreign investors in Taiwan Stock Exchange
This paper investigates foreign investors trading in Taiwans stock markets. Total
foreign ownership, including foreign direct investments, individual investors, and QFIIs,
was 7.01% in 1994, increased to 16.91% in 2000, and has further increased to 31.84% in
2005. It shows that foreign ownership rapidly rose in recent years.
The trading value of individual investors accounts for 68.84% of total trading value
in TSEC, implying that individual investors are majority in Taiwan stock market. The
percentage of foreign investors is only 17.87%. This figure indicates that foreign investors
trade less actively than domestic investors do.
2.3. Sample construction
There are a total of 691 listed companies in TSE at the end of December 2005. Total
listed companies are ranked by their foreign ownership. We choose top 20 highest foreign
ownership firms as sample in this study. The data sources regarding foreign ownership
and firm characteristics are from the TEJ Equity Database, TEJ Finance Database, and
TEJ Company Database. All of these databases are maintained by Taiwan Economic
Journal (TEJ).
Table 1 lists the sample firm data, including securities code, names, capitalization,
number of shares outstanding, and percentage of shares held by foreign investors. Market

Foreigner Investors and Stock Volatility: Evidence from Taiwan

319

Table 1. Samples This table lists the sample firms in this study. Cap is the closing
price times the number of shares outstanding. Cap, number of shares outstanding, and
percentage of shares held by foreign investors are measured at the end December 2005.
Securities
Code
2330
2308
2029
2311
1439
2317
9917
1527
2324
2409
2891
2353
2301
2325
2332
2411
3044
2327
1614
2430

Securities Name

TSMC
DELTA ELECTRONICS
Sheng Yu Steel
A. S. E.
Chu Wa Wool
HON HAI
Taiwan Secom
Basso
COMPAL
AUO
Chinatrust Group.
ACER
LTC
SILICONWARE
D-LINK
Phonixtec Power
TRIPOD
YAGEO
SANYO
TKE

Cap
(NT$ million)
1,545,627
123,185
7,740
137,373
810
736,960
22,226
11,346
105,865
285,697
184,359
185,998
117,360
107,247
22,904
16,895
30,567
33,691
5,303
13,297

Number of shares
outstanding
(million shares)
24724.6
1778.5
321.2
4550.5
92.0
4031.9
440.1
152.5
3516.4
5830.5
7090.7
2254.5
2601.8
2303.1
609.2
471.9
307.9
2406.5
316.6
242.2

Percentage of
shares held by
foreign investors
75.88
65.80
65.59
62.89
62.00
58.13
55.55
53.28
51.30
50.85
50.69
50.33
50.16
49.37
49.13
48.47
48.38
48.35
47.97
47.42

capitalization is the closing price times the number of shares outstanding. Percentage of
shares held by foreign investors is the total shares held by foreign investors divided by
total shares outstanding. These figures are based on information on December 31, 2005.
The firm has the highest foreign ownership is TSMC (TSEC code is 2330), and followed by Delta Electronics (TSEC code is 2308). The foreign ownerships at the end 2005
are 75.88% and 65.80%, respectively. The market capitalization of TSMC is NT$1,546
billion, the largest firm in Taiwan stock market.
Interestingly, the aggregated market capitalizations for 20 sample firms is NT$3.69
trillion, accounting for 23.63% of total market capitalization in TSEC at the end of 2005.
This implies that foreign investors prefer large stocks, and is consistent with the findings
in Kang and Stulz (1997) and Lin and Shiu (2003).2
2 Kang and Stulz (1997) examine the foreign ownership in Japanese stock market, while Lin and Shiu (2003)
study the foreign ownership in Taiwan Stock Exchange, in which the same target as this study.

320

Information and Management Sciences, Vol. 19, No. 2, June, 2008

3. Empirical Model
Some literature studying foreign trading and volatility was based on unconditional
volatility. It is not appropriate because unconditional volatility measure may be failed to
capture the dynamic changes of volatility. In this study, we employ the GARCH model
to capture the dynamic relations of foreign investors trade and conditional volatility.
Our measure for foreign investors trade is a concept like as order imbalance. First,
for each sample firm, we calculate the buy and sell volume (lots) of foreign investors.
Then the net buy volume is the deduction of the sell volume from buy volume. A
negative net buy volume means that the stocks sell by foreign investors are higher than
buy by foreign investors on that day. Finally, the net buy volume is normalized by total
shares outstanding. This normalized net foreign purchase, F P , is our measure for foreign
investors trade.
In our preliminary test (not shown here), most of the stock returns in our sample
period have an autocorrelation at lag one. In order to have a uniform presentation in
the text, we choose the same lags for all sample firms. Previous literature suggests that
the relation of volume and return is essential.3 Therefore, we use the daily turnover to
capture the return and volume relation.
Since the good news and bad news may have an asymmetric effect on conditional
volatility, we consider the GJR-GARCH model to examine the impact of foreign trade
on conditional volatility. The GJR-GARCH model is proposed by Glosten, Jagannathan
and Runkle (1993), and the advantage of the model is its ability to capture different
effects of good and bad news on conditional volatility. The GJR-GRACH is very similar
to the Threshold GARCH model.
Based on the analyses above, an AR(1)-GJR-GARCH(1, 1) model is suggested to
model the relationship:
Rt = c0 + a1 Rt1 + a2 T U RNt1 + a3 F Tt + et ,

et = vt ht , vt iid N(0, 1),

ht = c1 + 1 e2t1 + 1 ht1 + 1 e2t1 It1

+ 1 T U RNt1 + 2 |F Tt |

where Rt is the daily return for sample firms, T U RNt1 is the lagged turnover (which is
an exogenous variable to capture the return and volume relation as previously discussed),
3 Please refer to discussions in Karpoff (1987), Easley, OHara, and Paperman (1998), and Easley, OHara,
and Srinivas (1998).

Foreigner Investors and Stock Volatility: Evidence from Taiwan

321

and F Tt is foreign investors trade, term |F Tt | is foreign investors trade in absolute value.

It is dummy variable which equals to one if et < 0 and 0 otherwise.

In the mean equation, we test the impact of foreign trade on concurrent stock return.
If foreign investors buy stocks (F P > 0) and concurrent stock price goes up, and if foreign
investors sell stocks (F P < 0) and concurrent stock price goes down, then the coefficient
a3 is expected to be positive. In the variance equation, because we will examine the
impact of foreign trade on stock return volatility, the absolute value of F P rather than
the sign of F P are essential. Therefore, we use the absolute value of F P in the variance
equation. If foreign investors trade increases stock volatility, then the sign of 2 in the
variance equation is predicted to be positive.
4. Empirical Results
In this section, we first present the descriptive statistics for the variables used in the
analysis. Then we report the estimated results of empirical model. Finally, we have a
discussion on the empirical results.
4.1. Descriptive statistics
Our empirical period is from January 2000 to September 2006, totally 1,694 trading
days. We collect the daily return, turnover, foreign ownership, and the trade of foreign
investors from the TEJ Equity Database, TEJ Finance Database, and TEJ Company
Database, all of which are maintained by Taiwan Economic Journal (TEJ).
For each firm, we calculate the means and medians of foreign ownership, turnover, return, and the normalized foreign purchase (F P ) over the sample period. These statistics
are given in Table 2.
Foreign ownership in Table 2 is different from the one in Table 1 because the former
is measured over the whole sample period. For example, the mean of foreign ownership
in TSMC in the sample period (code: 2330) is 52.73% and the median is 52.05% (in
Table 2), while the foreign ownership on December 31, 2005 is 75.88% (in Table 1). The
changes of foreign ownership in Table 2 are no longer monotonic, reflecting the fact that
foreign investors have different preferences across firms during sample period.
The means and medians of turnover, return, and F P have a large variation across
sample firms. The mean of daily turnover varies from 0.1448% (code: 1614) to 2.4877%
(code: 2332). All of the means and medians of F P are non-negative, indicating that
foreign investors stand on the buy-side during the sample period. This is consistent with

Foreign Ownership (%)

Turnover
(%)

Return
(%)

Net Foreign Purchase

(102 100%)

Mean

Median

Mean

Median

Mean

Median

Mean

Median

2330
2308
2029
2311
1439
2317
9917
1527
2324
2409
2891

0.5273
0.5008
0.6538
0.4800
0.5929
0.4438
0.3970
0.2613
0.3757
0.2446
0.4797

0.5205
0.4760
0.6524
0.4732
0.6068
0.4277
0.3665
0.2923
0.3538
0.2241
0.5129

0.2415
0.6459
0.7747
0.7003
0.4301
0.3643
0.3347
0.9693
0.7967
1.8192
0.4119

0.2000
0.4200
0.3700
0.5500
0.1500
0.2900
0.2100
0.5500
0.5700
1.5100
0.3300

0.0326
0.0743
0.0685
0.0138
0.0468
0.1041
0.0322
0.0307
0.0281
0.1402
0.0558

0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000

0.1945
0.2064
0.0049
0.1260
0.0000
0.1651
0.1736
0.1631
0.2187
0.2729
0.1940

0.0970
0.1148
0.0000
0.0659
0.0000
0.1322
0.0095
0.0000
0.1370
0.1351
0.1470

2353
2301
2325
2332
2411
3044
2327
1614
2430

0.1826
0.2274
0.3571
0.2690
0.3597
0.2347
0.3198
0.4850
0.2622

0.0982
0.1926
0.3742
0.2645
0.3924
0.3199
0.3409
0.4809
0.2209

1.5793
1.4727
0.9800
2.4877
0.4663
1.0014
1.8439
0.1448
1.7144

0.6700
0.8600
0.8200
1.7000
0.2700
0.5400
1.2900
0.0500
0.8100

0.0335
0.1117
0.0461
0.0596
0.0450
0.1887
0.0128
0.0854
0.0498

0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000

0.1685
0.2901
0.1936
0.1741
0.1388
0.4506
0.2164
0.0416
0.2870

0.0000
0.0260
0.1067
0.0789
0.0319
0.0000
0.0646
0.0000
0.0000

Information and Management Sciences, Vol. 19, No. 2, June, 2008

Securities Code

322

Table 2. Descriptive Statistics for Sample Firms This table reports the mean and median of daily foreign ownership, turnover, return, and net
foreign purchase during the sample period for each sample. Foreign ownership is the number of shares held by foreign investors divided by total
outstanding shares. Turnover is the daily trading volume scaled by total shares outstanding. Net Foreign Purchase is the difference of shares
purchase and sell by foreign investors, and then dividend by total shares outstanding.

Foreigner Investors and Stock Volatility: Evidence from Taiwan

323

the trends that foreign ownership rapidly raised in Taiwan stock market. However, the
positive F P is potentially attributed to the sample bias because we choose top 20 highest
foreign ownership firms at the end 2005.
4.2. Estimated results
Table 3 gives the estimated results of the AR(1)-GJR-GARCH(1, 1) model. We
report both coefficients and t-statistics (in parentheses) in the mean and variance equations. We also report the Ljung-Box Q(12) statistics for checking residuals from the
mean equation.
Results in the mean equation show that after controlling for autocorrelation of market return and lagged turnover, normalized foreign purchases have a significant impact
on concurrent stock return. Among the 20 sample firms, there are 19 firms have a significantly positive coefficients on FT. This suggests that stock price tends to appreciate
when the foreign investors buy more than sell in that stock. In other words, the trade
of foreign investors has a significantly positive impact on concurrent stock return.
In the variance equation, 15 firms have a positive coefficient of 2 , and 12 of them are
significant, implying the trade of foreign investors tend to increase conditional volatility.
When foreign investors buy or sell large quantity shares of a stock, the absolute value of
order imbalance, F P , is large, and the significantly positive sign of |F P | will magnify
the conditional volatility. Therefore, our results suggest that the trade of foreign investors
has a positive impact on stock volatility.
Most of the coefficients of 1 are significantly positive. This is consistent with the
findings in Glosten, Jagannathan and Runkle (1993). The good news and bad news have
different impact on stock volatility. The responses of stock prices to bad news are much
stronger than that to good news.
The Ljung-Box Q(12) statistics for the mean equations vary from 4.70 to 20.90. All
of them fail to reject the white-noise residual hypotheses at the 5 percent level.4
4.3. Discussion
Our results show that foreign investors trades increase stock return volatility. We
ask a question: Do foreign investors destabilize the local markets? Although foreign
investors trades make stock price more volatile, we do not think that foreign investors are
blame for the market failure. Our following analysis demonstrates that foreign investors
play the role of discovering price rather than destabilizing in local markets.
4

The 5 percent level of critical value for Chi-squared distribution with 12 degrees of freedom is 21.03.

where Rr is the daily return, T U RNt1 is the lagged daily turnover, F Tt is the foreign trading, volume scaled by total shares outstanding. These
variables are described in Table 2. It is dummy variable which equals to one if et < 0 and 0 otherwise. Q(12) in the variance equation are Ljung-Box
Q statistics. The 5 percent level of critical value for Chi-squared distribution with 12 degrees of freedom is 21.03. Sample period is from 1/1/2000
to 9/30/2006, 1694 observations for each firm. The numbers in parentheses are t-statistics.
Firm code
2330
2308
2029
2311
1439
2317
9917
1527
2324
2409

Rt = c0 + a1 Rt1 + a2 T U RNt1 + a3 F Tt + et
c0

a1

a2

-0.1229

-0.1350

(-1.24)

(-5.28)

-0.0556

-0.0739

(-0.88)

(-2.83)

-0.0235
(-0.36)

ht = c1 + 1 e2t1 + 1 ht1 + 1 e2t1 It1

+ 1 T U RNt1 + 2 |F Tt |

a3

c1

-0.2014

1.417

-0.1140

(-0.44)

(24.87)

(-0.98)

-0.0948

0.7699

-0.0276

(-0.90)

(17.17)

(-0.46)

0.0716

0.0330

0.3536

0.0772

(2.82)

(0.48)

(3.94)

(4.43)

-0.0297

-0.0280

-0.1316

0.6649

0.3563

(-0.28)

(-1.11)

(-1.02)

(18.36)

(2.50)

0.1194

0.0512

-0.2687

-0.0393

1.6122

(1.81)

(1.78)

(-5.41)

(-0.56)

(7.55)

-0.1360

-0.1263

0.1027

1.1520

-0.1108

(-1.77)

(-5.28)

(0.46)

(27.61)

0.0269

0.0684

-0.3516

0.5095

(0.52)

(2.66)

(-2.17)

0.0081

-0.0544

(0.17)

(-2.40)

-0.0921

-0.1075

(-1.30)

(-4.64)

-0.1923

-0.0468

(-1.66)

(-1.59)

0.0543

0.4899

0.2552

3.1624

1.5120

(2.66)

(14.25)

(6.04)

(4.11)

(12.12)

0.0700

0.6780

0.1714

0.8592

0.5900

(3.38)

(21.08)

(3.76)

(4.38)

(7.85)

0.0752

0.9093

-0.0030

0.0417

-0.0362

(5.33)

(77.26)

(-0.20)

(1.56)

(-0.53)

0.0651

0.8373

0.0871

-0.1605

0.1877

(3.48)

(26.58)

(2.78)

(-1.24)

(2.71)

0.2204

0.5416

0.0482

-0.0763

-0.0677

(5.40)

(11.05)

(0.88)

(-5.63)

(-17.37)

0.0255

0.6571

0.2275

2.3944

0.2625

(-1.36)

(1.53)

(18.84)

(5.57)

(4.97)

(3.10)

0.1047

0.0846

0.6238

0.2034

1.3759

0.3981

(15.91)

(2.64)

(3.91)

(18.73)

(4.39)

(7.08)

(6.75)

-0.0469

0.2227

0.0048

0.0364

0.9353

0.0289

0.0503

0.0107

(-1.06)

(15.83)

(0.67)

(4.57)

(125.09)

(2.31)

(2.48)

(2.20)

-0.0589

0.5545

0.0179

0.0364

0.8963

0.0873

0.0832

0.0607

(-0.70)

(21.13)

(0.72)

(2.90)

(60.13)

(3.65)

(1.48)

(2.32)

0.1016

0.4294

0.1447

0.0332

0.9525

0.0055

0.0307

0.0040

(1.58)

(18.88)

(0.40)

(3.20)

(83.08)

(0.38)

(0.83)

(0.20)

Q(12)
20.415
9.08
15.88
15.38
15.25
19.43
11.92
12.84
20.65
7.91

Information and Management Sciences, Vol. 19, No. 2, June, 2008

+ 1 T U RNt1 + 2 |F Tt |,
ht = c1 + 1 e2t1 + 1 ht1 + 1 e2t1 It1

324

Table 3. GARCH Model

This table shows the Threshold GARCH model estimate results. An AR(1)-TGRCH(1, 1) model is specified to test the effect of foreign trading on
stock return and volatility:

Rt = c0 + a1 Rt1 + a2 T U RNt1 + a3 F Tt + et , et = vt ht , vt iid N (0, 1),

Table 3. (Cont.)
Firm code

Rt = c0 + a1 Rt1 + a2 T U RNt1 + a3 F Tt + et
c0

a1

a2

-0.0824

-0.1093

(-1.19)

(-3.49)

2353

-0.1085

-0.1079

(-1.84)
2301

-0.2165
(-3.37)

2891

2325

2411
3044
2327
1614
2430

a3

c1

0.0203

0.6775

-0.0703

(0.12)

(18.96)

(-2.90)

0.0775

0.8058

0.0358

0.1319

0.3179

(3.86)

(35.95)

(1.13)

(1.03)

(6.34)

0.0188

0.5993

-0.0228

0.0393

0.8783

0.1037

0.1676

0.0711

(-4.45)

(0.47)

(23.64)

-0.0184

0.0783

0.5188

(-0.71)

(2.95)

(54.24)

(4.28)

(2.93)

(2.92)

0.0003

0.0474

0.8998

0.0568

0.1390

0.0271

(-0.73)

(1.60)

(13.20)

(0.01)

(3.59)

(54.28)

(2.66)

(3.21)

(1.14)

0.0980

-0.0152

(0.73)

(-0.65)

-0.1465

0.4283

0.0678

0.0171

0.9543

0.0445

0.0365

-0.0182

(-1.20)

(16.79)

(0.97)

(2.00)

(94.70)

(2.66)

(0.53)

(-0.56)

-0.0441

0.0434

(-0.58)

(1.71)

-0.0090

0.2335

0.0992

0.0296

0.8895

0.0919

0.0960

-0.0050

(-0.29)

(12.94)

(2.67)

(2.85)

(50.05)

(3.60)

(2.69)

(-0.21)

-0.0578

-0.0577

(-0.87)

(-2.16)

-0.0812

0.6080

0.3714

0.0651

0.5385

0.2674

1.5020

0.7919

(-0.58)

(16.06)

(3.84)

(2.62)

(13.19)

(4.49)

(4.10)

(6.73)

0.0886

-0.0154

(1.08)

(-0.54)

-0.0441

0.2846

0.1020

0.0388

0.9238

0.0327

-0.0001

0.0149

(-0.86)

(12.00)

(2.40)

(3.27)

(60.57)

(1.57)

(-0.00)

(1.26)

-0.0221

0.0414

(-0.22)

(1.60)

-0.0552

0.3726

0.5625

0.0416

0.7741

0.1346

0.3478

-0.0162

(-1.12)

(14.36)

(3.00)

(2.06)

(18.73)

(3.41)

(3.12)

(-0.26)

0.0850

-0.0531

(2.06)

(-1.99)

-0.0200

0.6976

0.0415

0.1241

0.9044

-0.0816

-0.0257

0.1327

(-0.09)

(10.87)

(5.09)

(9.72)

(106.02)

(-6.03)

(-0.46)

(2.63)

-0.0934
(-1.41)

0.0640

0.0116

0.2793

0.2834

0.0955

0.7210

0.1475

0.3177

0.2558

(2.32)

(0.33)

(7.94)

(4.77)

(4.22)

(23.75)

(3.38)

(4.42)

(5.58)

Q(12)
18.64
18.25
4.70
11.70
20.12
18.41
20.90
16.07
6.56
5.03

Foreigner Investors and Stock Volatility: Evidence from Taiwan

2332

ht = c1 + 1 e2t1 + 1 ht1 + 1 e2t1 It1

+ 1 T U RNt1 + 2 |F Tt |

325

326

Information and Management Sciences, Vol. 19, No. 2, June, 2008

The raised volatility by trade of foreign investors has two alternative causes. If
foreign investors trade has a predictive power for future return, then we may interpret
that foreign investors trade is a price discovery. That is, when foreign investors buy
more (less) than sell, this stock prices go up (down) in the following days, then foreign
investors have the ability to push the stock price push price back to equilibrium by
trading local stocks. The foreign investors trade is informative.
Alternatively, if the foreign investors trade does not have a predictive power for
future return, the accompanied high volatility would be classified as excess volatility
and their trade is uninformative. More specifically, the trends of stock price in the
following days are uncorrelated or inversely correlated to the trade of foreign investors,
then foreign investors destabilize the market because their trades cause stock price excess
volatile without information.
The concurrent effect of foreign investors trade on return, the coefficient a3 in Table
3, may provide some pieces of evidence. There are 19 out of 20 firms have a significantly
positive coefficient a3 , implying that foreign investors trade has a positive impact on
concurrent return.
Furthermore, we borrow the results from Lai and Shiu (2007). Lai and Shiu (2007)
examine the relation of foreign investors trade and future returns. Their sample covers
281 firms in Taiwan Stock Exchange, and sample period is from 1994/7/1 to 2002/1/31.
They find that foreign investors trade has a significantly positive impact on future returns
up to the following 10 days.
Given the evidences, we conclude that although foreign investors trade increases
stock volatility, their trade has a function of a price discovery.
5. Conclusion
Although stock market open to global investors has lowered the cost of equity capital,
authorities in many emerging markets still view foreign investors as enemies because
foreign investors tend to cause excess volatilities and thus destabilize local markets.
Policy makers in emerging markets always worry about the advantage of lower cost of
equity capital will be offset by the excess volatile caused by foreign investors. Particularly,
foreign investors tend to follow positive feedback strategies, herd, and trade without
information during the financial crisis.
This paper examines the impact of foreign investors trade on stock volatility. The
sample firms are 20 firms with the highest foreign ownership in Taiwan Stock Exchange.

Foreigner Investors and Stock Volatility: Evidence from Taiwan

327

Sample period is from January 2000 to September 2006. We find that foreign investors
prefer large local stocks, consistent with the previous literature.
We find that foreigners trade not only has a positive relation on concurrent return
but also increases conditional volatility. The stock price becomes more volatile when
foreign investors buy or sell more shares of stock. Because foreigners trade has a predictive for future returns, we argue that foreign investors play the role of price discovery by
trading local stocks. When the prices of local stocks deviate from intrinsic value, foreign
investors trade to push price back to equilibrium. Foreign investors improve the market
efficiency by trading local stocks.

References
[1] Choe, H., Kho, B. and Stulz, R. M., Do foreign investors destabilize stock markets? The Korean
experience in 1997. Journal of Financial Economics, Vol. 54, pp.227-264, 1999.
[2] Choe, H., Kho, B. and Stulz, R. M., Do domestic investors have more valuable information about
individual stocks than foreign investors? Working paper, Ohio State University, 2000.
[3] Easley, D., OHara, M. and Paperman, J., Financial analysts and information-based trade, Journal
of Financial Markets, Vol. 1, pp.175-201, 1998.
[4] Easley, D., OHara, M. and Srinivas, P. S., Option volume and stock prices: Evidence on where
informed traders trade, Journal of Finance, Vol. 53, pp.431-465, 1998.
[5] Glosten, L., Jagannathan, R. and Runkle, D., On the relation between the expected value and the
volatility of the nominal excess return on stocks, Journal of Finance, Vol. 48, pp.1779-1801, 1993.
[6] Hamao, Y. and Mei, J., Living with the enemy: an analysis of foreign investment in the Japanese
equity market, Journal of International Money and Finance, Vol. 20, pp.715-735, 2001.
[7] Kaminsky, G., Lyons, R. K. and Schmukler, S. L., Mutual fund investment in emerging markets: An
overview, World Bank Economic Review, Vol. 15, pp.315-340, 2002.
[8] Kaminsky, G., Lyons, R. K. and Schmukler, S. L., Managers, investors, and crises: mutual fund
strategies in emerging markets, Journal of International Economics, Vol. 64, pp.113-134, 2004.
[9] Kang, J. K. and Stulz, R. M., Why is there a home bias? An analysis of foreign portfolio equity
ownership in Japan, Journal of Financial Economics, Vol. 46, pp.3-28, 1997.
[10] Karpoff, J. M., The relation between price changes and trading volume: A survey, Journal of Financial
and Quantitative Analysis, Vol. 22, 109-126, 1987.
[11] Kim, E. H. and Singal, V., Stock market openings: Experience of emerging economics, Journal of
Business, Vol. 73, pp.25-66, 2000.
[12] Kim, W. and Wei, S.-J., Foreign portfolio investors before and during a crisis, Journal of International
Economics, Vol. 56, pp.77-96, 2002.
[13] Lai, C. and Shiu, C., Do foreign investors trade can predict future returns? Evidence from Taiwan.
Working paper, National Central University, Taiwan 2007.
[14] Lin, C. H. and Shiu, C., Foreign ownership in the Taiwan stock market: An empirical analysis,
Journal of Multinational Financial Management, Vol. 13, pp.19-41, 2003.
[15] Miles, W., Financial deregulation and volatility in emerging equity markets, Journal of Economic
Development, Vol. 27, No. 2, pp.113-126, 2002.

328

Information and Management Sciences, Vol. 19, No. 2, June, 2008

Authors Information
Chia-Jui Lai is currently an assistant professor in the Department of Finance, Dahan Institute of Technology, Hualien, Taiwan, R.O.C.. He received his M.S. degree in Applied Mathematics from National
Chengchi University, Taipei, Taiwan in 1993, and the Ph.D. degree in Accounting from Zhongnan University of Economics and Law, Wuhan, China, His research interests are applied statistics, empirical
finance.
Department of Finance, Dahan Institute of Technology, Hualien, Taiwan, R.O.C.
Kuo-Ren Lou is currently an associate professor in the Department of Management Sciences & Decision
Making at Tamkang University in Taiwan. He received his Ph.D. degree in the Department of Statistics
from the University of Connecticut, U.S.A.
Department of Management Sciences & Decision Making, Tamkang University, Tamsui, Taipei, 25137,
Taiwan, R.O.C.
E-mail: 109880@mail.tku,edu.tw

TEL : +886-2-2621-5656 ext 2845

Cheng-Yi Shiu is currently an assistant professor in the Department of Finance, National Central University, Taiwan, R.O.C.. He received his Ph.D. in Finance from National Chengchi Univesrity, Taiwan.
His research interests are Corporate Finance, International Investment, and Empirical Finance.
Department of Finance, National Central University, Taoyuan, 320, Taiwan, R.O.C.
E-mail: cshiu@ncu.edu.tw

TEL : +886-3-422-7151 ext. 66268.