Home field advantage: Lambeau Field, Adelphia Coliseum, Reilly Center, Cameron Indoor Stadium, and the Korean Stock Market?
Do domestic investors have an edge?
The trading experience of foreign investors in Korea
Choe, Kho, and Stulz show that home field advantages do not just exist in sports, but also in finance!
They look at all trades on the Korean stock exchange for a two year period ending in November 1998 and “show that foreign money managers pay more than domestic money managers when they buy and receive less when they sell for medium and large trades.” However there does not appear to be a difference for small stocks trades (that is when the size of the trade is small).
As the authors point out, “There are at least three non-mutually exclusive explanations for this result. First, foreign investors could be more impatient or trade when liquidity is lower, so that they pay more to liquidity providers. Second, foreign investors are better informed, so that their trades have a larger permanent impact. Third, they make their trades after prices have already moved against them.”
Interestingly, they find evidence to rule out both the liquidity and the information hypotheses. Thus, they conclude that “the difference between foreign investors and domestic investors is that prices move unfavorably for foreign investors than for domestic investors immediately before they trade intensively. This difference is partly explained by the return-chasing behavior of foreign investors.”
How big of disadvantage is it for the foreign trader? “On a roundtrip trade foreign money managers face greater transaction costs of the order of 37 basis points compared to domestic money managers, which is substantial” “For instance, an investor who trades three times per year would contemplate a drag on his performance in excess of 100 basis points. To put this in perspective, Carhart (1997) reports that the difference in the monthly estimates of Jensen’s alpha between the top decile and the bottom decile of diversified mutual funds in the U.S. is 0.67% from 1963 through 1993.(See, for instance, Grinblatt and Keloharju (2000), Seasholes (2000), and Froot and Ramadorai (2001)”
While I found the article fascinating, it would be interesting to see if foreign investors were somehow tipping off their trades—maybe a different mechanism is followed, that would allow front running to exist.