Trading Behavior, Performance, and Stock Preference of Foreigners, Local Institutions, and Individual Investors: Evidence from the Korean Stock Market

We examine the trading behavior and performance of foreigners, local institutions, and individual investors in the Korean stock market. The key research issue is whether the commonly-documented information disadvantage of foreign investors translates into their underperformance relative to local institutional and individual investors. Our results show the opposite, that the stocks foreigners buy significantly outperform the stocks they sell in terms of both stock returns and operating profitability, leading to the significant outperformance of foreigners' trading strategies over those of local investors. Our results provide strong evidence that the superior performance of foreigners is attributed to their ability to discern between company stocks with good versus bad, at least short-term, prospects. Our findings on the trading behavior of investors in the Korean market are, in general, consistent with those for other markets documented in the published literature. Foreigners behave like short-term momentum traders pursuing a growth strategy. Local institutions also trade like momentum traders but tend to buy value stocks. In contrast, individual investors trade like contrarians who buy past losers and sell past winners. Our findings show that foreigners prefer large-cap stocks with high dividends. In sharp contrast, individual investors have a strong preference for small-cap, high-leverage, low dividend paying stocks, whereas local institutions tend to buy small-cap, low leveraged stocks.