Foreign institutional investor trading in Chinese A-share markets

Purpose – This paper addresses the topic “The interaction between financial institutions and firms in the nonfinancial sectors” in the special issue of “Banking and finance in China.” The purpose of this paper is to examine the trading behavior and price effects of foreign institutions under the celebrated Qualified Foreign Institutional Investor (QFII) scheme on all non-financial firms in the Chinese A-share markets. Design/methodology/approach – Using quarterly equity-level foreign institution transactions from 2005Q1 to 2011Q4 in the Chinese A-share market, the author finds a positive and significant contemporaneous relationship between foreign flows and equity returns. For each quarter, the author sorts the stocks into ten portfolios based on the percentage of foreign flows, and employs the bivariate vector autoregression (VAR) model to examine the contemporaneous association in detail. Findings – Foreign institutions in the Chinese A-share markets do not show positive or negative feedback trading; however, their flows have a strong impact on future equity returns because of informational advantage. Additionally, different associations are found between foreign flows and equity returns. Research limitations/implications – Constraints on data availability exist, and a quarterly dimension is too coarse to provide a statistically precise result, although certain related papers use quarterly dimension data. Further research is required using higher frequency data. Originality/value – This paper provides a first look at foreign institution trading patterns and price effects on local equity returns in the Chinese A-share markets. Additionally, the equity level data allow the author to exclude the stocks that were not bought by foreign institutions and to detect the “pure effect” of foreign flows on equity returns.