The foreign portfolio investment flows, stock prices and exchange rate before and after the global financial crisis : a comparative study between Korea and Thailand

Abstract

The purpose of the present study is to investigate the behavior of foreign flows

and their impacts on the stock market, especially on stock prices and exchange rate.

This research investigates the results of two Asian countries, Thailand and Korea,

separating the analysis into three periods: pre-global financial crisis, global financial

crisis and post-global financial crisis. The daily data are used with a structural VAR

model with three endogenous variables: stock returns, currency returns and foreign

normalized net purchases with exogenous global returns. The results reveal positive

feedback for trading behavior with respect to local stock returns in both Thailand and

Korea before the crisis, but insignificant behavior during the crisis and post-crisis

periods. Local currency depreciation lowers stock prices in terms of foreign currency

and promotes net purchases of foreign investors. An increase in global returns promotes

net purchases of foreign investors into the local stock markets during all periods.

Therefore, based on these results, it can be concluded that the positive feedback trading

behavior with respect to local stock returns and currency returns does not exist during

the crisis period. Foreign investors will consider only global returns in all periods.

The results reveal the positive correlation between foreign net purchases and

stock returns. In addition, the predictable and unpredictable component of foreign net

flows appears to be a significant driver of local stock returns. The increase in foreign

net purchase revalues local currency because the foreign demand for local stock should

lead to an appreciation in local currency. Moreover, the results show that foreign net

purchases lead to a change in stock prices volatility and exchange rate volatility. In

addition, the behavior of both local institutes and investors is to trade against foreign

investors, a negative feedback trading behavior with respect to local stock returns. The

results of the comparison between the Thai stock market and Korean stock market

demonstrate stronger impacts of foreign flows and market capitalization on the Thai

market, which is a relatively smaller economy than on the Korean market.

In addition, the variance decomposition results show that currency returns have

the most impact on foreign net purchases when compared with stock returns and global

returns. Thus, currency returns were the most important factor for foreign investment

decision making during the sample periods in both Thailand and Korea. Therefore, the

policies to control the fluctuation in exchange rate will also help reduce the fluctuation

in stock market. Policy implication of exchange rate stabilization may be an appropriate

choice to prevent the fluctuation in the exchange rate and stock market.

The results of this research demonstrate the behavior of foreign flows such as

market returns, currency returns and global returns. These factors can be employed as

leading indicators for foreign investors’ decision of inflows and outflows, which can be

very useful for tendency prediction of foreign flows in the future. Moreover, these

results of the impacts of foreign flows on stock markets can provide useful information

for analysis and recommendations for trading decisions in order to gain the greatest

benefits from foreign buying as well as avoid the negative impacts of foreign selling as

well.