The role of stock valuation differences in explaining the diverging stock holdings of foreign and local investors

Abstract

There are a number of factors that have been shown to influence the differing stock selection preferences of foreign and domestic investors. Following a rather new approach by Kang, Lee and Park (2010), this paper reexamines the influence that differing benchmarks employed for their respective stock valuation can have on the stock allocation of foreign and local investors in a particular market and extends it in several different ways. Foreigners in this regard are expected to employ an international benchmark while local investors, presumed as home-biased, will use a local valuation benchmark instead. The investor group that puts a higher valuation on a certain set of stocks should consequently hold a higher proportion of those shares - which contributes to explain their stock allocation. Contrary to prior findings by the before mentioned authors, this given study does not find evidence of the expected relationship using a similar approach with panel data from Thailand; the results rather indicate an exact opposite relationship. Additionally, this study also finds that there is an asymmetry in the effect and the valuation difference only has a significant influence on the foreign ownership levels when the foreign valuation exceeds the domestic one. Trading activity is generally lower in the case of relatively favorable foreign valuation and subsequent stock returns generally go down. The results of this study support the findings by Kang et al. only in the way that the two different investor groups seem to relate to differing benchmarks for asset pricing- however not in the expected way. Given the opposing findings, further research seems warranted.