Does Foreign Investment Worsen the Domestic Stock Market During a Financial Crisis? Evidence from Taiwan

Foreign portfolio investment is a major means by which emerging stock markets accumulate capital. However, the high mobility of foreign funds is a concern for local investors and policymakers in emerging countries because it may induce high stock price volatility. In this study, we utilized a riskbased approach to investigate whether the stocks most favored by foreign investors are riskier than those least favored by foreign investors. We distinguished our sample stocks into foreign most-favored and foreign least-favored groups and classified our data periods into a financial crisis period and an aftermath period. We then estimated the 1% VaRs and expected maximum losses through a GARCH– extreme value theory–copula methodology for the foreign most-favored and least-favored groups. The empirical results indicated that the foreign most-favored group had lower 1% VaRs than the foreign least-favored group during both the financial crisis and its aftermath. However, the foreign mostfavored group had higher expected maximum losses than the foreign least-favored group. Thus, although stocks favored by foreign investors may not be riskier in general, investing in these stocks could still occasion disaster in an extreme event.