Foreign institutional investors, information advantage, and equity returns : evidence from China

Abstract

Using foreign and domestic institutional ownership data in Chinese A-share markets, we document a significantly positive relation between the level of foreign institutional ownership and future stock returns after controlling for several explanatory variables of the cross-sectional stock returns, including firm size, book-to-market ratio and past returns. More importantly, change in foreign institutional ownership forecasts future stock returns. This return predictability is stronger for small and young firms with greater information asymmetries and does not reverse in the long run. By contrast, neither the level of nor change in domestic institutional ownership predicts future stock returns. Overall, our results are consistent with the perspective that foreign institutional investors in China are better informed because of their superior information-processing capability.