Imitate the masters: Do foreign institutional investors improve the informational efficiency of stock prices in China?

Abstract

OBJECTIVES OF THE STUDY:

Over the past decade, Qualified Foreign Institutional Investors (QFIIs) have become more and more important in China's A-share markets. This thesis aims at investigating the impacts of foreign institutional ownership on the informational efficiency of A-share prices, and identifying some economic mechanisms through which foreign institutional ownership affects the informational efficiency. The mechanisms examined in this thesis include foreign institutional trading activities, the famousness level of QFIIs, and the QFIIs' accessibilities to local information.

DATA AND METHODOLOGY:

In this thesis, I examine the impacts of seventy-two active QFIIs on the informational efficiency of China's A-share price from 2004 to 2012. Among the 2,444 A-shares which were listed on either Shanghai Stock Exchange or Shenzhen Stock Exchange by the end of June 2012, 1,061 A-shares were or had been held by the seventy-two QFIIs. The informational efficiency of A-share prices is measured as the extent to which prices deviate from a random walk over short time intervals (e.g. five- and thirty-minute). To study the relationship between foreign institutional holdings and the informational efficiency, I employ multivariate OLS regression models. In addition, I use various dependent variables and control variables, and conduct a two stage-least square test to ensure the robustness of the empirical results.

RESULTS:

The empirical results suggest that foreign institutional ownership significantly improves the informational efficiency of China's A-share prices, when controlling for stock liquidity and turnover. Foreign institutional trading also has a positive effect on the information environment of A-shares, but the relative strength of foreign holdings effect and foreign trading effect depends on A-shares' previous price efficiency. Moreover, QFIIs which are more famous and have access to local information about Chinese markets tend to have greater enhancing effects on the informational efficiency of A-share prices.