Foreigners Stocks Investment and Financial Markets Instability in East Asia during the 2007-2009 Global Financial Crisis

Abstract

This paper investigates the question of whether the stability of financial markets is damaged by

foreigners stock investment by estimating its dynamic relationships with stock price and exchange rate

in East Asia, focusing on the 2007-2009 global financial crisis. We find that the negative effects of

foreigners stock investment on stock price and exchange rate are much stronger during a crisis than in

normal times in many East Asian countries. This finding suggests that foreigners stock investment

could act as a destabilizing factor in domestic financial markets, especially in the face of global

financial disturbances. In particular, the Korean exchange market is found to be most vulnerable to the

global shocks among East Asian countries.

As the impact of the global common shocks turns out to be very substantial in East Asian countries,

policy makers should strengthen financial cooperation within this region. Increasing the intra-regional

trades in stocks is expected to promote the financial stability in this region by providing opportunities

for sharing investment risks among East Asian countries. In addition, regulatory measure such as the

Tobin tax may be useful in limiting capital movements against a possible crisis.