Please use this identifier to cite or link to this item: https://hdl.handle.net/2440/84758
Type: Thesis
Title: How foreign trades affect domestic market liquidity: a transaction level analysis.
Author: Peranginangin, Yessy Arnold
Issue Date: 2014
School/Discipline: Business School
Abstract: The extant literature has documented the significance of foreign trades on domestic markets as well as the importance of commonality in liquidity in a market, but it seems to be silent on how foreign trades affect commonality in liquidity, especially at the transaction level. The lack of research that investigates this line of enquiry provides the overarching research theme for this thesis. To investigate the research theme I use transaction data from the Indonesian Stock Exchange (IDX) that allows me to identify the trading activities of foreign-versus-domestic investors on a trade-by-trade basis. I find that foreign investors enhance commonality in spread when they initiate trades on both sides of the market which are motivated either by differences in interpreting information or by the desire to trade immediately, but not by information asymmetry. This finding is surprising given the prevalence of asymmetric information evidence surrounding domestic and foreign interaction and the proposition of Chordia, Roll and Subrahmanyam (2000) suggesting that information asymmetry could induce commonality in liquidity. The lack of evidence to link information asymmetry between domestic and foreign investors and commonality in liquidity, along with the findings indicating that foreigners trade more aggressively than locals, lead me to raise and investigate a follow up research question. This second research question is why do foreigners have a propensity to place more aggressive orders as costs associated with these trades are higher? Investigating the second research question, I find more evidence to exclude information asymmetry as the channel through which foreigners affect commonality in liquidity and find more evidence to support the finding that foreigners affect commonality in liquidity through their desire to trade immediately. This finding implies that an inventory risks explanation is more appropriate in explaining the impact of foreign trades on commonality in liquidity. Given that foreign trades are aggressive and this affects commonality in liquidity, I then examine whether their trades are motivated by information advantage. Using price discovery analysis, I find that domestic investors make a greater contribution to the price discovery process compared to foreign investors and the contribution of domestic investors to the price discovery process can be explained by domestic and foreign interactions. Furthermore, analysing the information types that are reflected in domestic and foreign price series, I find that domestic prices reflect firm-specific information while foreign price series reflect systematic information. These findings, along with the findings on the price discovery analysis, seem to suggest that the low contribution of foreign investors to the price discovery process could be due to the fact that they base their investment decisions on systematic information, rather than firm-specific information. In summary, I find evidence suggesting that foreign investors affect commonality in liquidity through their needs of immediacy rather than information asymmetry. The evidence also suggests that there is a mutually-beneficial relationship between foreign (net) liquidity demanders and domestic (net) liquidity suppliers. This enduring relationship holds up very well during the 2008 financial crisis, demonstrating its resilience.
Advisor: Zurbruegg, Ralf
Ali, Syed
Brockman, Paul
Dissertation Note: Thesis (Ph.D.) -- University of Adelaide, Business School, 2014
Keywords: liquidity; commonality in liquidity; foreign investors
Provenance: This electronic version is made publicly available by the University of Adelaide in accordance with its open access policy for student theses. Copyright in this thesis remains with the author. This thesis may incorporate third party material which has been used by the author pursuant to Fair Dealing exceptions. If you are the owner of any included third party copyright material you wish to be removed from this electronic version, please complete the take down form located at: http://www.adelaide.edu.au/legals
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