Do foreign institutions improve stock liquity?

• Main Author: WEI, Chi Shen
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2010
• Subjects: Institutional Investors; Foreign Investors; Liquidity; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/6779; https://ink.library.smu.edu.sg/context/lkcsb_research/article/7778/viewcontent/SSRN_id1571220.pdf
• Institution: Singapore Management University

This paper examines whether capital flows by foreign institutions improve liquidity in domestic markets. I find that stocks with increased foreign institutional ownership subsequently experience higher liquidity. However, it is difficult to interpret this evidence as a causal relation because institutions tend to self-select into more liquid stocks. To solve this problem, I exploit the 2003 US dividend tax cut as a natural experiment. The results from a 2SLS (IV) regression confirm that liquidity improved more in dividend-paying stocks located in US tax-treaty countries compared to similar stocks located in non-treaty countries. These patterns are consistent with the notion that institutions improve liquidity through a variety of channels including information competition and greater liquidity trading.