Foreign portfolio flows and emerging markets: lessons from Thailand

Emerging markets are generally small and fairly illiquid. Thus, extreme price volatility is a matter of concern as a slight change in trading activity can assert significant pressure on prices. It comes as no surprise that the movement of foreign equity flows exert significant influences in emerging markets as they have tremendously increased over the last two decades subsequent to a general trend in continued liberalization around the world, especially in Asia Pacific. This research focuses on the effect of foreign flows on emerging market returns and addresses several empirical asset pricing issues in the Asia Pacific markets by using the data from the Thai stock exchange. The dissertation provides a quantitative assessment on the impact of foreign portfolio flows on the Thai equity market before, during, and after the Asian financial crisis. The study investigates the differential impact of foreign equity flows on the pricing and volatility of the aggregate market and of two market segments; one consisting of stocks that are favored by foreign investors and the other less favored. The empirical results reveal that the price pressure impact on the first segment is more positive. This finding corroborates with the fact that the flow betas which measure the exposure to unexpected foreign flows are mostly positive (negative) for stocks with high (low) foreign interest. The cross-sectional analysis finds that exposure to unexpected flows has a significant valuation impact for stocks in the first segment, but not for those in the second. The study finds no evidence to suggest that foreign investors cause excess volatility in the market. Rather, it appears that the extraordinarily high volatility during the crisis period is related to domestic selling as foreign investors are net buyers, and thus liquidity providers during that period. Recognizing the importance of foreign flow in promoting trading activity, my study shows that the impact of foreign flow on market volatility may be erroneously magnified without controlling for market liquidity. These results hold in both market segments.