Foreign Equity Portfolio Flows and Local Markets: Two Examples from the Istanbul Stock Exchange

This thesis analyzes the nature of foreign equity trades in relation to their effectson local markets. My goal is to contribute to the understanding of equity flows of foreign investors and their effect on the local markets. The thesis consists of twochapters, both of which employ a novel data set that is consisted of monthly equityflows by foreign investors at Istanbul Stock Exchange of Turkey.The first chapter, Foreign Ownership and World Market Integration, aims to explain the de facto financial market integration with global markets with foreign equityownership using a novel data set of foreign portfolio flows at the individual stock level.The main result is the positive link between global nancial integration and past portfolio in flows by foreign investors on the cross-section of local stocks. The results have high economic significance: Across individual stocks a 1.4% increase in foreign portfolio inflows corresponds to up to 3.3% greater relative explanatory power of the global factor in explaining local stock returns in the following month. The results are indicative of a causal link: The lead-lag effect between foreign portfolio inflows and financial integration does not exist in the opposite direction. I show that stocks that experience an increase in foreign ownership are not more financially integrated in the past, i.e. the foreign portfolio flows are not a response to increased financial integration.The second chapter is titled as Uninformed Momentum Traders and it studies therelationship between momentum trading and information. I present evidence thatsupports the hypothesis that momentum trading is linked to a lack of information. Idocument significant momentum trading by foreign investors in stocks on which theypotentially have more informational disadvantages. Small stocks, stocks with highvolatility and low liquidity, stocks that are financially less integrated and have greater foreign exchange risk are subject to greater momentum trading. Moreover, stocks onwhich foreign trades indicate lower future profitability are subject to higher momentum trading. Additionally, I show that momentum trades by foreign investors exertcontemporaneous price pressure and have no valuable longer-run information content.The contemporaneous price pressure of 2.30% per month is followed by a significantreturn reversal in the following two quarters. Finally, there is strong evidence that foreign investors do not possess local market speci c information. Momentum tradingby foreign investors is triggered by the past profitability of the momentum factor inthe local market. However, the negative pro tability of momentum makes momentum trading a sub-optimal trading strategy.