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Does investor base heterogeneity affect price volatility?[17-10]
Author(s)
임태훈
The date
07 June 2017
Publications
Capital and Financial Markets
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specifically, this paper analyzes the effect of investor-base homogeneity on stock price volatility.
I consider the strategic complementarity among investors as the channel through which investor base can affect price volatility. Strategic complementarity is a concept that represents the situation in which optimal strategies among economic agents form a complementary relationship. It serves as a core element of theories that try to explain financial market instability such as bank run, bubble formation and the following bust.
In this study, I examine the hypothesis that the lower diversity of the investor base, the more likely the strategic complementarity between investors will manifest and therefore the price volatility will increase. We selected individual stocks in 23 MSCI advanced markets and 23 emerging markets, and focused on the effect of changes in the investor base caused by foreign investors on stock price volatility.
The basic hypothesis is that price volatility increases as investor base diversity is reduced. This main hypothesis is divided into two sub hypotheses. The first hypothesis is that when increase in the level of foreign ownership diversifies the entire investor base, they should lower the price volatility and have the opposite effect when they reduce the diversity. The second hypothesis predicts that the price volatility should decrease along with foreign investor diversity when the level of participation of foreign investors is high.
Cross-sectional analysis was conducted to test the hypothesis on the effect of foreign ownership on price volatility. The results of the analysis show that the price volatility increases with the level of foreign ownership where the foreign institutional investor turnover is high, but for the stocks with lower foreign ownership turnover the price volatility decreases with foreign ownership. This result empirically supports the first hypothesis. The test results of the second hypothesis show that the foreign investor base diversity reduces price volatility for the stocks that had high foreign institutional investor turnover.
The following implications can be derived from this study. First, it should be noted that the effects of the increase in foreign investment may appear to have different effects depending on foreign institutional investor activity levels. If there is relatively little foreign investment activity, the increase in foreign investment can be expected to have a positive effect of diversifying the investor base thus lowering price volatility. On the other hand, if foreign investment activity is high, the increase in foreign investment may increase the price volatility. 
Second, as foreign investment growth is expected to continue, diversity of foreign investors should be monitored. Since foreign investors are directly affected by the changes of the international financial environment and exchange rates, the level of homogeneity among foreign investors is intrinsically high. Therefore, it is important to understand whether the foreign investor base is concentrated in a specific country and whether there is a similarity among the investment strategies. 
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