NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Did Foreign Investors Cause Asian Market Problem?



"if Soros rigged the ringgit's collapse so he could profit from it -- as Malaysia's Mahathir alleged -- it is curious that his three funds only broke even during the meltdown."

The role that foreign portfolio investors have played in Asia's ongoing financial market crisis has been a topic of much speculation and debate. In many countries, fickle or downright sinister foreigners have been blamed for driving down currencies and stock prices. Meanwhile, the broader question of whether free flow of capital is really such a good thing is now being taken up even in the United States. What's been missing, though, is much empirical data on the role of hedge funds, mutual funds, and other foreign institutional investors in the market meltdowns of 1997. Two new NBER Working Papers, one focusing on Southeast Asian currency markets and the other on the Korean stock market, attempt to fill that gap, and both find little or no hard evidence that foreign investors were behind the market declines.

Hedge funds that speculate in currencies around the globe have been the most oft-cited scapegoats for Southeast Asia's meltdown. Last year, Malaysian Prime Minister Mahathir Mohamad wrote in the Wall Street Journal that hedge fund operators such as George Soros had driven down the Malaysian ringgit "to enrich themselves and their rich clients." But in Hedge Funds and the Asian Currency Crisis, (NBER Working Paper No. 6427), Stephen Brown, James Park, and NBER Research Associate William Goetzmann find no indication that major hedge funds profited from the collapse of Malaysia's ringgit or other Southeast Asian currencies during the summer and early fall of 1997. In fact, the ten large hedge funds they studied do not appear to have had large exposures --negative or positive-- to the ringgit in the summer of 1997, and they appear to have been buying into the currency as it collapsed in August and September 1997.

There are problems with the data on hedge funds' currency exposures used by Brown, Park, and Goetzmann, though. Because hedge funds release no data on their holdings, the three researchers had to estimate exposures to the ringgit and other currencies by correlating the hedge funds' returns with exchange rate changes. Brown, Park, and Goetzmann acknowledge that these calculations may misrepresent the funds' true exposures. Still, they argue, if Soros rigged the ringgit's collapse so he could profit from it -- as Malaysia's Mahathir alleged -- it is curious that his three funds only broke even during the meltdown.

In Do Foreign Investors Destabilize Stock Markets? The Korean Experience in 1997 (NBER Working Paper No. 6661), Hyuk Choe, Bong-Chan Kho, and NBER Research Associate Rene Stulz have much more data to work with. Because of restrictions on foreign ownership of South Korean corporations, the Korean Stock Exchange keeps detailed records of stock purchases and sales by foreign investors. Examining data from 1996 to the end of 1997, Choe, Kho, and Stulz find ample evidence that foreign investors behave in a manner that could be destabilizing. They move in herds, often buying and selling the same stocks at the same time, and they engage in positive feedback trading -- that is, they buy stocks that have recently gone up in price and sell stocks that have recently gone down. But when the three researchers tried to pin down evidence that stampeding foreign investors started or even exacerbated the Korean stock market collapse of the last three months of 1997, they could find almost none. After examining days, and five-minute periods within trading days, when foreign selling was much higher than foreign buying on the Korean exchange, they concluded that "there is no evidence that large foreign selling is a prelude to falling stock prices."

-- Justin Fox


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