Asymmetric investor behavior between buyside and sellside: Evidence from investor classes in the Sri Lankan stock market

J. of Multi. Fin. Manag. 20 (2010) 93–113

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Journal of Multinational FinancialManagement

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Asymmetric investor behavior between buyside andsellside: Evidence from investor classes in the Sri Lankanstock market

Lalith P. Samarakoon ∗

Opus College of Business, University of St. Thomas, 2115 Summit Ave., St. Paul, MN 55105, USA

a r t i c l e i n f o

Article history:Received 26 December 2009Received in revised form 26 April 2010Accepted 24 July 2010Available online 3 August 2010

JEL classification:F3G11G15

Keywords:Equity flowsPositive feedback tradingContrarian tradingForeign investorsDomestic investorsEmerging markets

a b s t r a c t

Using unique trading data for investor classes from Sri Lanka,this study finds asymmetric investor behavior between buy-side and sellside in large trades. Investors are positive feedbacktraders on the buyside and contrarians on the sellside. Domesticinvestors exhibit more feedback and contrarian behavior than for-eign investors, suggesting that foreign investors are more informedon the buyside and less informed on the sellside. Individuals aremore feedback and contrarian traders than institutions. Foreigninstitutional investor sales do not precede, coincide with, or leadto significant returns. Trades do not lead to price momentum orreversals, but leave a permanent positive price effect.

© 2010 Elsevier B.V. All rights reserved.

1. Introduction

Evidence on behavior of foreign and domestic investors, both institutional and individual, in theirbuy and sell trades in emerging markets has become increasingly mixed. Some studies suggest thatcertain investors, such as foreign investors, are positive feedback traders while others find that they

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94 L.P. Samarakoon / J. of Multi. Fin. Manag. 20 (2010) 93–113

Fig. 1. Daily turnover matrix of the Sri Lankan stock marketThe contribution of trades between each investor-class to the daily market turnover (the value of shares traded). The investorclasses are domestic institutional investors (DC), domestic individual investors (DI), foreign institutional investors (FC), andforeign individual investors (FI).

act in a contrarian manner. The existing evidence on the relative information advantages of differ-ent investor classes is also varied and controversial. Some studies show that foreign investors aremore informed than domestic investors, whereas others contend that domestic investors have aninformation advantage. Given the rapid growth of international portfolio investments and increasingintegration of world stock markets, examining the trading behavior of different investor classes andunderstanding implications for relative information advantages of investors is extremely important.

One of the primary motivations of this study is to investigate the relation between equity flowsand returns using a unique data set from the emerging market of Sri Lanka. The data contain all dailytrades of all investor types, i.e. foreign and domestic, each further classified into institutional andindividual, for the 12-year period from 1993 to 2004. This data represent the longest daily disaggre-gated data of this nature that has been examined in any emerging stock market. The high frequency ofdata makes the investigation more interesting and statistically reliable in detecting relations betweenreturns and flows that are otherwise hidden in monthly or quarterly data used in most previous work.The data enable the classification of each trade by the identity of the buyer and the seller into fourtypes of investors; domestic institutional investors, domestic individual investors, foreign institutionalinvestors, and foreign individual investors (see Fig. 1). The intersection of each buyside investor andsellside investor generates a matrix of 16 possible trades among these four investor types. The abilityto examine the behavior of equity flows across all investor types in a single market makes this studyvery unique and interesting.1

This study has two main research objectives. The first objective is to investigate whether investorsexhibit any particular trading behavior, such as positive feedback and contrarian trading, on theirbuyside and sellside trades. The study examines the returns preceding large trades to understand anysuch behavior. The second objective is to investigate whether trades lead to price momentum and havea permanent effect on subsequent stock prices. The study examines this issue through the behavior ofreturns following large trades. This study examines the returns surrounding large purchases and salesof each investor class using an inter-day event-study methodology to fully characterize the behaviorof returns before and after large equity flows.

1 Most previous studies use aggregate and low-frequency data. Froot et al. (2001) point out the limitations of such analysisin understanding the behavior of international portfolio flows. None of the previous studies examines the investor behavioracross all investor classes in a single study.

L.P. Samarakoon / J. of Multi. Fin. Manag. 20 (2010) 93–113 95

In addition to the data used in this study being unique, this paper is motivated by the empiri-cal results that show a number of important insights into the trading behavior of different investortypes in an emerging market. First, the results provide compelling evidence of asymmetric investorbehavior on the buyside versus sellside trades. All investor types are positive feedback traders onthe buyside, except when they purchase from foreign institutional investors. In contrast, all investortypes, except foreign institutional investors, are contrarian traders on the sellside. The central mes-sage is that, except when the seller is a foreign institutional investor, all four investor types showstrong evidence of positive feedback trading when they purchase and contrarian trading when theysell. Although there are number of previous studies showing positive feedback and contrarian tradingby various types of investors in international markets, these studies focus only on one or two classesof investors, mostly foreign and domestic institutional investors and do not consider trades betweeninvestor classes.2 Unlike prior studies, the present study shows that not only there exists an asym-metric behavior between buyside and sellside trades, but also such behavior is remarkably pervasiveacross all investor classes—foreign, domestic, institutional, and individual.

Second, different from previous research, the ability to examine trades of all investor typesas well as trades between investor types (inter-investor trades) enables this paper to completelydescribe the relative strength of positive feedback and contrarian behavior among investor types.The results point to a number of important patterns regarding the relative magnitude of positivefeedback and contrarian trading among investors. Past returns have the most impact on trades ofdomestic investors, and past returns preceding trades of domestic investors are higher than thosepreceding trades of foreign investors. This gives clear evidence of domestic investors exhibitingmore feedback trading as well as more contrarian behavior than foreign investors. Similarly, indi-vidual investors show more feedback and more contrarian behavior than institutional investors,domestic institutional investors are more contrarian than foreign institutional investors, and foreignindividual investors are more contrarian than domestic individual investors. There have not beenprior studies that provide such a vivid perspective on the differences in behavior among investorclasses in an emerging market. Hence, this study makes an important contribution to the litera-ture.

Third, this study provides important insights into the trades by foreign institutional investors. Whileforeign institutional investors act like positive feedback traders on the buyside when they buy fromdomestic institutional investors, domestic individual investors, and foreign individual investors, theydo not exhibit such behavior when they buy from other foreign institutional investors. Sales of foreigninstitutional investors do not demonstrate contrarian behavior either. The important conclusion fromthis buyside and sellside behavior is that sales of foreign institutional investors are not triggered byrecent return performance of stocks. Further, foreign institutional investors do not show a propensityfor selling stocks after a significant price increase or a decrease. Possibly, their sales decisions aredriven by other factors, such as portfolio rebalancing due to changes in global, regional, and countryasset allocation decisions.

These findings have important implications for the relative informedness of different investor types.In the spirit of information asymmetry models, this evidence of differences in returns prior to large pur-chases and sales by a particular investor type can be interpreted as signifying the relative informednessof that investor type. In the asymmetric information models of Brennan and Cao (1997) and Brennanet al. (2005), when domestic investors are more informed than foreign investors, less-informed for-eign investors become more bullish (bearish) and buy from (sell to) domestic investors when returnsincrease (decrease), resulting in trend-following behavior of foreign investors. They also conjecturethat the expectations of less-informed foreign investors are more sensitive to new information and,consequently, they respond more elastically to information than more-informed domestic investors.A more-informed investor possesses more precise signals and higher quality information. Therefore,the information asymmetry theory implies that a more-informed investor is more likely to purchasea stock following a small run-up in stock price than after a large run-up. As a result, returns preced-

2 See, for example, Froot et al. (1998), Choe et al. (1999 and 2001), Grinblatt and Keloharju (2000a), Hamao and Mei (2001),Karolyi (2002), Kim and Wei (2002), and Dahlquist and Robertsson (2004).


ing purchases by more-informed investors are likely to be less than returns preceding purchases byless-informed investors.

Consistent with the above asymmetric information arguments, the results of this paper imply that,on the buyside, foreign investors are more informed than domestic investors, because foreign investorsare less positive feedback traders, i.e. they buy following a smaller positive return than domesticinvestors do. The results also imply that institutional investors are more informed than individualinvestors. There is no difference in relative information endowments between domestic and foreigninstitutional investors and between domestic and foreign individual investors on their buyside trades.

The information asymmetry hypothesis can be extended to explain the differences in contrarianbehavior of investor types on the sellside as well. A more-informed investor is likely to sell stocksat higher prices than a less-informed investor, resulting in larger returns before sales by a more-informed investor. The magnitude of the price difference might serve as a proxy for informationasymmetry between two investor types. The larger the information asymmetry the larger the dif-ference between prices at which a more-informed and a less-informed investors would sell stocks. Inthe context of the reported results, the return differentials on the sellside imply that domestic investorsare more informed than foreign investors, individual investors are more informed than institutionalinvestors, domestic institutional investors are more informed than foreign institutional investors, andforeign individual investors are more informed than domestic individual investors. Foreign institu-tional investors do not exhibit any discernible behavior suggesting that they are the least informed onthe sellside. However, it is plausible that other factors, such as country and asset allocation decisions,might explain this behavior of foreign institutional investors.

Why would foreign investors be more informed on the buyside and less informed on the sellside?One plausible reason is that foreign investors spend relatively more time and effort on informationacquisition, security analysis, and selection before entering into positions than when they exit frompositions. They have to justify the rationale for buy decisions on the basis of factors, such as earningsprojections and valuations. They also have access to high-quality research and information producedby larger and most-often foreign-affiliated brokerage firms, which employ better-trained and expe-rienced analysts.3 In fact, the data of this study show that 78% of the value of transactions of foreigninvestors has been channeled through four foreign-affiliated brokers during the sample period.4 Hence,better information and superior analytical skills can explain why foreign investors are more informedthan domestic investor on the buyside.5 Turning to the sellside results, better information and analyt-ical skills could be dominated by any potential information disadvantages that might otherwise arisedue to geographical, linguistic, or cultural barriers.6 It is also plausible that having made the invest-ments, foreign investors spend less time and resources to regularly monitor the conditions of theirinvestments than domestic investors. The intensity of information collection and analysis that is asso-ciated with the entry can dissipate over time. Foreign investors may not necessarily have dedicatedanalysts monitoring the securities in various markets in which they invest, and the buying broker isunlikely to provide a close monitoring service to the foreign investor either.7 Further, the turnoverof managers and analysts can contribute to less monitoring. In contrast, new information, which ismostly generated in the market where they reside, is transmitted to domestic investors conveniently,at virtually no cost, and faster. As a result, domestic investors can be more informed about currentconditions on an on-going basis than foreign investors, and foreign investors could potentially become

3 Using Indonesian data, Dvorak (2005) finds that clients of global brokerages earn higher profits than clients of local broker-ages, and that a combination of local information and global expertise leads to higher profits.

4 The share of value of transactions of foreign investors for the four brokers with foreign affiliations is as follows: CT Smithstockbrokers (34%), Asia Securities (16%), HDF Securities (14%), and John Keels Stockbrokers (14%).

5 Grinblatt and Keloharju (2000a), and Seasholes (2004) argue that foreign investors, particularly institutions, should be moreinformed than domestic investors due to access to expertise and analytical talent.

6 For example, physical propinquity (Coval and Moskowitz, 1999a, 1999b; Grinblatt and Keloharju, 2001), location, andlanguage (Hau, 2001).

7 Brennan and Cao (1997) also point out that it is rare for foreign institutional investors to have dedicated analysts monitoringvarious foreign countries. Frankel and Schmukler (1996) find that local investors have an informational advantage over foreigninvestors during times of crisis in Mexico.


less informed than domestic investors on the sellside. In a nutshell, often-cited information disadvan-tages of foreign investors are, in fact, more likely to be dominant when foreigners sell than when theybuy foreign equities.

Although it might not be appropriate to generalize these conclusions based on a single marketto other markets, it is possible to underscore some of the similar results found in other markets.The present study reports evidence of positive feedback trading by all investor types on the buy-side trades, except when the seller is a foreign institutional investor. Previous studies show positivefeedback trading by foreign institutional investors in developed and emerging markets (Froot et al.,2001), institutional investors in the U.S. (Badrinath and Wahal, 2002), non-resident foreign institu-tional investors in Korea (Kim and Wei, 2002), foreign investors in Korea (Choe et al., 1999), foreigninvestors in Finland (Grinblatt and Keloharju, 2000a), foreign investors in Japan (Karolyi, 2002), andforeign investors in Sweden (Dahlquist and Robertsson, 2004). Another key finding of the currentstudy is that all investor types, except foreign institutional investors, are contrarian traders on thesellside. There is previous evidence of contrarian behavior of foreign investors and domestic individ-ual investors (Choe et al., 1999), foreign investors in Japan (Hamao and Mei, 2001), foreign investorsin Korea (Choe et al., 1999), domestic investors in Finland (Grinblatt and Keloharju, 2000a, 2000b),Japanese institutional investors (Karolyi, 2002), resident foreign institutional investors in Korea (Kimand Wei, 2002), and individual investors in the U.S. (Barber and Odean, 2000). Heterogeneous behaviorof investors has been found in the U.S. as well. For example, De Bondt (1993) investigates the impact ofrepresentativeness on behavior and finds that some people act as trend followers and other act as con-trarians. On the issue of the relative informedness of investors types, Grinblatt and Keloharju (2000a),Froot and Ramadorai (2001), and Seasholes (2004) show that foreigners are more informed than localinvestors, while Choe et al. (2001) and Hau (2001) provide evidence that foreign investors are lessinformed than domestic investors. Thus, using different methodologies, previous studies show evi-dence of various investor types exhibiting positive feedback and contrarian trading behavior in manymarkets, both developed and emerging, around the world.

The remainder of this paper is organized as follows: Section 2 presents a summary of relatedliterature. Section 3 gives a description of the Sri Lankan stock market and data. Section 4 outlines theresearch design including sample selection and the event-study framework. The results are discussedin Section 5. Finally, Section 6 provides the conclusions of the study.

2. Related literature

How do investors behave when they buy and sell stocks? The existing literature examines this issueby looking at returns associated with trades in the period preceding, concurrent with, and followingsuch trades.

Positive feedback trading is defined as buying after price increases and selling after price declines,whereas contrarian trading is defined as buying after price decreases and selling after price increases.Previous empirical work on positive feedback trading has largely concentrated on testing the existenceof a positive relation between returns and equity flows. Using monthly data on U.S. net purchases inforeign markets, Bohn and Tesar (1996) found that net purchases were positively correlated withcontemporaneous as well as expected domestic returns. Using daily data by investor classes, Choeet al. (1999) showed that, before the Korean crisis period, foreign investors acted as positive feed-back traders in their buy trades and contrarians in their sell trades. Thus, there is previous evidenceof asymmetric investor behavior in the Korean market. They also found that domestic individualinvestors were contrarian traders with respect to past stock returns both before and during the Koreancrisis. Karolyi (2002) found positive feedback trading among foreign investors in Japan and contrar-ian trading among the Japanese banks, financial institutions, investment trusts, and companies. Inanother study using daily data, Froot et al. (2001) showed that concurrent and lagged returns stronglyinfluence portfolio flows of foreign institutional investors. Using monthly data on foreign investors’positions in Korea, Kim and Wei (2002) reported that non-resident foreign institutional investors inKorea are more likely to be positive feedback traders than resident foreign institutions or resident for-eign individuals. Grinblatt and Keloharju (2000a), using daily data on shareholdings of Finnish stocks,showed that foreign investors tend to be momentum investors who buy past winners and sell past


losers. Based on monthly portfolio investments in Swedish stocks by foreign investors, Dahlquist andRobertsson (2004) found that foreign investors increased their net holding in firms that had recentlyperformed well. Using quarterly data, Brennan and Cao (1997) showed a positive relation between U.S.net purchases in developed foreign markets and concurrent domestic returns, and a positive relationbetween lagged U.S. purchases in emerging markets and domestic returns. Shen et al. (2005) foundthat momentum profits are concentrated in growth indices in international markets.

Positive feedback or trend-following behavior begs the important question as to what drives suchbehavior. Brennan and Cao (1997), and Brennan et al. (2005) posited asymmetry of information amongdifferent investors about asset prices as a plausible explanation for the trend-following behavior offoreign investors. Brennan and Cao (1997) argued that the positive correlation between foreign pur-chases and concurrent foreign market returns reflects asymmetry of information between domesticand foreign investors.8 They showed that in a model where foreign investors are less-informed thandomestic investors,9 foreign investors purchase stocks from domestic investors when asset prices riseand, thus, tend to exhibit trend-following behavior. The intuition here is that, in response to a publicsignal, less-informed foreign investors revise their assessment of expected payoffs faster than more-informed domestic investors, leading foreign investors to purchase from domestic investors whenasset prices rise.

Under the assumption that domestic investors are more informed than foreign investors aboutpayoffs of domestic assets, Brennan et al. (2005) argued that expectations of foreign investors becomemore sensitive to new public information than those of domestic investors. This leads foreign investorsto buy from domestic investors when there is good news and asset prices rise, and sell to domesticinvestors when there is bad news and asset prices decline, resulting in trend-following behavior. Intheir model, if a group of investors become more bullish about a market when its return is positive, thenthat group of investors is at an informational disadvantage relative to all investors in the market. Usingmonthly survey data of institutional money managers investing in developed markets,10 Brennan etal. (2005) showed that institutional investors become more bullish about a country as the returns ofthat country increase and become more bearish when the returns decrease. This evidence confirmsthat foreign institutional investors are less-informed than domestic investors and engage in trend-following behavior consistent with the asymmetric information theory.

In contrast to the evidence of positive feedback trading, some studies report evidence of contrarianbehavior by investors. Choe et al. (1999) found that, before the Korean crisis period, foreign investorsacted as contrarians when they sell. They also found that domestic individual investors were contrar-ian traders with respect to past stock returns both before and during the Korean crisis. Grinblatt andKeloharju (2000a) reported contrarian behavior of Finish domestic investors, particularly households.Grinblatt and Keloharju (2000b) showed that less-sophisticated investors, such as households in Fin-land, are more predisposed to sell than to buy stocks with large past returns, exhibiting contrarianbehavior. Kim and Wei (2002) examined trades of foreign investors before and during the Koreancrisis and found that resident foreign institutional investors are contrarian traders before the crisis.Hamao and Mei (2001) showed evidence of contrarian behavior of foreign investors in the Japanesemarket. Brennan and Cao (1997) argued that, if foreign investors receive a less precise signal thandomestic investors, foreign investors could become contrarians in that they will become net sellers.Since domestic investors have a more precise good signal and are more informed, the prices will rise.Further, Odean (1998) found that individual investors tend to sell past winners and hold on to pastlosers. Barber and Odean (2000) also reported that individual investors are anti-momentum investorsin the U.S. Swanson and Lin (2005) examined momentum strategies in international equity markets

8 However, Brennan and Cao (1997) recognized that the positive association between flows and concurrent returns couldalso result from exogenous shifts investors’ demand for foreign stocks or a price impact of such flows.

9 This information asymmetry between foreign and domestic investors can be due to numerous factors including substantialefforts required to acquire information about foreign markets, time lag in information transmission and acquisition, and differ-ences in intensity of monitoring the performance and information on the stocks which the investors have bought. These factorsare particularly relevant in respect of emerging markets. See Brennan and Cao (1997) for a discussion of some of these factors.

10 The data include investors domiciled in the U.K., Japan, and U.S., and domestic markets of the E.U., the U.K., Japan, and U.S.from 1995 to 2000.


and found evidence of winners-momentum trading and losers-contrarian trading in developed andemerging markets.

Studies that examine returns subsequent to equity flows primarily deal with the issue of price con-tinuations or momentum. Prices exhibit positive momentum when prices keep rising after purchasesor when prices keep falling after sales. Prices exhibit negative momentum when prices keep fallingafter purchases or when prices keep rising after sales. Choe et al. (1999) found no evidence of pricecontinuations following foreign trades in the Korean stock market. Their results show that the marketadjusts quickly to large sales by foreign investors. In contrast, Froot et al. (2001) found that net foreignportfolio flows are correlated positively with future returns in emerging markets. Choe et al. (1999)argued that any price momentum can be indicative of a destabilizing effect. If the event-day returnsdo not reverse subsequently or prices continue to show positive momentum, then flows have a per-manent effect on prices. Any reversal of the event-day returns or negative momentum would reflecta temporary price effect of flows. A temporary effect is generally interpreted to be indicative of pricepressure exerted by trades. A permanent effect can be due to new information being incorporated intoprices (Brennan and Cao, 1997; Brennan et al., 2005), increased risk sharing (Stulz, 1999), or due toprices deviating from fundamental values (De Long et al., 1990).11 When flows cause prices to deviatefrom fundamentals and lead to bubbles, such flows are considered destabilizing in that the bubblescould eventually burst, resulting in market crashes. Choe et al. (1999) did not find evidence of pricecontinuations following large net foreign purchases and sales in the Korean market.

3. Description of the market and data

3.1. Sri Lankan stock market

The dearth of information about the Sri Lankan stock market in the literature calls for a briefdescription of the salient features of the market. Share trading in Sri Lanka, formerly known as Ceylon,began 110 years ago in 1896 under the British, primarily to finance the capital needs at the beginningphases of the tea plantations industry. Hence, Sri Lanka is one of the oldest stock markets in the world.During the market’s long history, it underwent periods of growth and decline due to changing politicalconditions and economic policies. The Sri Lankan stock market, in its present form, was established in1984 with the formation of the Colombo Stock Exchange (CSE).

Table 1 shows the key characteristics of the Sri Lankan stock market in the sample period of1993–2004. In 2004, the CSE had 242 listed stocks representing 20 industry sectors. The market capi-talization as a percent of the GDP averaged about 15%, while the market turnover as a percent of marketcapitalization also averaged about 15% during the sample period. The Sri Lankan market produced anaverage annual return (excluding dividends) of 8.5% in local currency terms. Since 2001, the markethas recorded more than 30% return every year with an average return of 35.5% in local currency terms.In terms of the number of shareholders, 98% of investors are domestic and 2% are foreign. Domesticindividual shareholders alone constitute 97% of the shareholders in the market. During the sampleperiod, on average, domestic investors owned 85% of the market, while foreign investors’ ownershipwas 15% of the market. Foreign ownership peaked at 20% of the market in 1997 and bottomed at 10%in 2001. However, foreign investors’ share in the turnover is about 32%, indicating the important roleplayed by foreign investors in share trading.

The Sri Lankan stock market was liberalized for foreign investors partially in June 1990 and com-pletely in March 1992. Foreign investment in equity is permitted, except in certain companies, whereforeign investment is restricted. The restricted companies include banks, insurance companies, hous-ing and mining firms, plantations, and companies that have restrictive provisions in their Articles ofAssociation. The capital gains tax was abolished in 1992, and there is no tax on capital gains for eitherforeign or local investors. The Securities and Exchange Commission of Sri Lanka, which was estab-lished in 1987, regulates the stock market. Insider trading is prohibited in Sri Lanka. There are 15 stock

11 De Long et al. (1990) posited that in the presence of positive feedback traders, rational speculation can be destabilizing. Theliterature on the impact of stock market liberalization on returns argues that liberalization leads to increased risk sharing andlower cost of capital (see Stulz, 1999; Bekaert and Harvey, 2000; and Henry, 2000).

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Table 1Characteristics of the Sri Lankan stock market: 1993–2004.

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Mean

Panel A: Trading statisticsNumber of listed firms 201 215 226 235 239 240 237 239 238 238 244 242 230Market capitalization (USD Mn.) 2504 2865 1977 1837 2112 1721 1564 1110 1332 1681 2717 3658 2040Turnover (USD Mn.) 446 690 208 131 299 269 206 138 151 316 763 566 332Turnover—local (%) 65 60 52 45 57 65 63 72 81 80 81 82 68Turnover—Foreign (%) 35 40 48 55 43 35 37 28 19 20 19 18 32Gross domestic product (USD Mn.) 10080 11586 12355 13545 14526 15019 15335 15709 15107 16354 18205 19400 14343Market capitalization/GDP (%) 24.84 24.73 16.00 13.57 14.54 11.46 10.20 7.06 8.81 10.28 14.92 18.86 14.68Turnover/market capitalization (%) 17.83 24.09 10.53 7.10 14.15 15.63 13.16 12.44 11.33 18.77 28.09 15.47 15.22

Panel B: ReturnsMarket return (Rs) % 61.73 0.79 −32.73 −9.15 16.45 −14.94 −4.15 −21.82 36.73 33.19 30.30 41.88 8.50Market return (USD) % 50.11 −0.05 −37.80 −13.42 7.75 −23.08 −9.92 −29.57 17.50 28.27 30.29 31.20 1.40Emerging market return (USD) % 71.26 −8.27 −6.94 3.92 −13.40 −27.52 62.97 −31.49 −4.91 −7.97 51.59 22.45 9.26

Panel C: Shareholders and ownershipNumber of shareholders NA NA 140089 143952 159611 237871 247741 256374 259664 267620 282913 299151 229499Domestic individual NA 132226 135989 139391 154328 232030 241474 249757 252742 260260 274847 290340 223116Foreign individual NA NA 935 1018 1148 1257 1353 1423 1482 1593 1783 2044 1404Domestic institutional NA 1701 1849 1923 2124 2365 2527 2660 2769 2950 3327 3720 2621Foreign institutional NA 1884 1316 1620 2011 2219 2387 2534 2671 2817 2956 3047 2358Domestic ownership/market cap (%) NA 82 84 84 80 84 85 89 90 88 86 86 85Foreign ownership/market cap (%) NA 18 16 16 20 16 15 11 10 12 14 14 15

This table shows the basic characteristics of the Colombo Stock Exchange (CSE) during the 12-year period from 1993 to 2004. The U.S. dollar denominated market capitalization, turnover,and the Gross Domestic Product (GDP) are computed using the year-end exchange rate between the Sri Lankan Rupee (Rs) and the U.S. Dollar (USD). The market return represents theannual change in the All Share Price Index. Emerging market returns are based on the Morgan Stanley Capital International Emerging Market Index. The number of listed firms and thenumber of shareholders are as of the end of each year. NA: data not available. Mean shareholder statistics are based on 1995–2004 data.


Table 2Equity flow variables used in the study.

Buyside investor Sellside investor

Domestic Foreign Total Grand total

DC DI FC FI

Domestic DC DCDC DCDI DCFC DCFI DCPDPDI DIDC DIDI DIFC DIFI DIP

Foreign FC FCDC FCDI FCFC FCFI FCPFPFI FIDC FIDI FIFC FIFI FIP

Total DCS DIS FCS FISTurnoverGrand total DS FS

The investor classes are domestic institutional investors (DC), domestic individual investors (DI), foreign institutional investors(FC) and foreign individual investors (FI). The turnover is equal to the sum of the following 16 equity flows between investorclasses: purchases of domestic institutional investors from domestic institutional investors (DCDC), purchases of domesticinstitutional investors from domestic individual investors (DCDI), purchases of domestic institutional investors from foreigninstitutional investors (DCFC), purchases of domestic institutional investors from foreign individual investors (DCFI), purchasesof domestic individual investors from domestic institutional investors (DIDC), purchases of domestic individual investors fromdomestic individual investors (DIDI), purchases of domestic individual investors from foreign institutional investors (DIFC),purchases of domestic individual investors from foreign individual investors (DIFI), purchases of foreign institutional investorsfrom domestic institutional investors (FCDC), purchases of foreign institutional investors from domestic individual investors(FCDI), purchases of foreign institutional investors from foreign institutional investors (FCFC), purchases of foreign institutionalinvestors from foreign individual investors (FCFI), purchases of foreign individual investors from domestic institutional investors(FIDC), purchases of foreign individual investors from domestic individual investors (FIDI), purchases of foreign individualinvestors from foreign institutional investors (FIFC), and purchases of foreign individual investors from foreign individualinvestors (FIFI). Row totals represent purchases of an investor class: domestic institutional purchases (DCP), domestic individualpurchases (DIP), foreign institutional purchases (FCP), and foreign individual purchases (FIP). Column totals represent sales of aninvestor class: domestic institutional sales (DCS), domestic individual sales (DIS), foreign institutional sales (FCS), and foreignindividual sales (FIS). Grand row totals represent domestic purchases (DP) and foreign purchases (FP), while grand columntotals represent domestic sales (DS) and foreign sales (FS).

brokering companies in the market. The Sri Lankan stock market is not a dealership market. Stockbrokers act as intermediaries to transactions and do not engage in market making. The trading on theColombo Stock Exchange is completely automated and considered one of the finest trading systemsin the world. The automated trading system was introduced in June 1997. Brokers are electronicallyconnected to a central computer, located at the CSE, which automatically executes orders on the basisof price-time priority. The settlement period is t + 5 for buy and t + 6 for sell transactions, where t isthe date of the trade. Transaction cost is 1.125% for transactions up to 1 million rupees and 1.025%for transactions exceeding that amount. Trading takes place on weekdays, except exchange holidays,from 9:30 A.M. to 12:30 P.M.

3.2. Data

This study uses daily equity flow data for each stock by each investor class, which are com-puted from transactions data obtained from the Colombo Stock Exchange. The equity flow for aninvestor group represents the total value of trades of that particular investor group on a givenday. The data cover the 12-year period from 1993 to 2004 and contain trades on 272 stocks.The data set enables identification of the buyer and the seller of each trade as domestic insti-tution (DC), domestic individual (DI), foreign institution (FC), and foreign individual (FI). Table 2shows the definitions of equity flows used. The trades are classified by the buyside and the sell-side investor class. From the viewpoint of the buyside investor, each cell represents purchasesfrom another investor, and from the perspective of the sellside investor, each cell represents salesto another investor. This study examines the behavior of purchases of investor groups as rep-resented by the row totals (DCP, DIP, FCP, FIP, DP, FP), the behavior of sales of investor groupsas represented by the column totals (DCS, DIS, FCS, FIS, DS, FS), and the behavior of equityflows between the four investor classes (inter-investor flows) as represented by the 16 inside


Table 3Turnover matrix.

% of average daily stock turnover

Buyside investor Sellside investor

Domestic Foreign Total Total

DC DI FC FI

DomesticDC 15.85 10.38 9.95 1.33 37.51

67.82DI 9.46 15.99 4.10 0.76 30.31Foreign

FC 9.67 5.56 13.46 0.43 29.1232.18FI 1.28 1.16 0.53 0.09 3.06

Total 36.26 33.09 28.04 2.61 100.00

Total 69.35 30.65 100.00

This table shows the breakdown of the average daily stock turnover (value of shares traded) in the sample of 115 stocks listed onthe Colombo Stock Exchange during the period from 1992 to 2004. Each cell represents the average daily value of transactionsof a stock between a buyside investor class and a sellside investor class as a percent of the average daily stock turnover. Theinvestor classes are domestic institutional investors (DC), domestic individual investors (DI), foreign institutional investors (FC),and foreign individual investors (FI). The rows represent the buyside investor while the columns represent the sellside investor.

cells (DCDC, DCDI, DCFC, DCFI, DIDC, DIDI, DIFC, DIFI, FCDC, FCDI, FCFC, FCFI, FIDC, FIDI, FIFC,FIFI).

The turnover matrix shown in Table 3 shows the value of shares traded and helps in understandingthe importance of trades among different investor classes. The single largest component of turnoveris trades between domestic individual investors (DIDI), which accounts for almost 16% of the averagedaily turnover of a stock. Trades between domestic institutional investors (DCDC) account for almostthe same proportion of turnover as the trades between domestic individual investors. The third largestcomponent of turnover is trades between foreign institutional investors (FCFC), which accounts for13.5% of the turnover. Other significant contributors are trades between domestic institutions anddomestic individuals (DCDI and DIDC), and trades between domestic and foreign institutions (DCFCand FCDC). The row totals in the turnover matrix indicate the composition of the turnover from theperspective of the buyside investor. Accordingly, the domestic institutional, domestic individual, andforeign institutional purchases contribute 38%, 30%, and 29% respectively to the turnover. On thesellside, as indicated by the column totals in the turnover matrix, domestic institutional, domesticindividual, and foreign institutional sales contribute 36%, 33%, and 28% respectively to the turnover.Considering both buyside and sellside trades, on average, domestic investors’ trades constitute 69%of turnover, while foreign investors’ trades form 31% of turnover. In relation to the average foreignownership of about 15% of total market capitalization of the CSE, their 31% share in the turnover clearlydemonstrates the foreign investors’ disproportionately larger role in trading activity in the Sri Lankanstock market. On average, institutional investors contribute 66% and individual investors contribute34% to the daily turnover.

The data are free of survivorship biases. They include all the stocks listed at anytime during thesample period. To minimize any biases arising from infrequent trading, this study filters out stocksthat trade less than 50% of the time on a daily basis. This results in a sample of 115 stocks. Theaverage trading frequency of the sample is 76%. The total number of transactions of the 115 companiesrepresents 87% of all the trades in the market during the 1993–2004 period. Thus, the study uses ahigh quality data set that captures almost 90% of the trading activity in the Sri Lankan stock market.

All 28 series of equity flows are measured in domestic currency, Sri Lankan Rupee (Rs). The AllShare Price Index, which is a value-weighted price index of all stocks listed on the Colombo StockExchange, represents the Sri Lankan market benchmark. The individual stock returns are continu-ously compounded daily total returns and adjusted for dividends, rights, and bonuses. All returns aremeasured in domestic currency terms.


4. Research design

4.1. Sample selection

This study employs an inter-day event study to characterize the behavior of returns before andafter large equity flows. The event study is designed similarly to the one implemented by Choe et al.(1999). For each of the 16 inter-investor equity flows in the turnover matrix, the days with the largest10% of the daily equity flows are chosen. For example, the study selects days with the largest 10% ofequity flows between domestic institutional investors and domestic institutional investors (DCDC),which is the first cell in the turnover matrix. Likewise, the study chooses days with the largest 10%of equity flows for the other 15 inter-investor flows. These days define the event days (day 0). Tominimize biases arising from infrequent trading, events are selected from the 115 firms for which thetrading frequency is at least 50%. The sampling procedure eliminates flows with a value less than 0.5million Rupees (approximately US$ 5000) to ensure a minimum size of flows.

One of the issues of event selection is the time distribution of events. Taking the days with thelargest 10% of flows leads to a disproportionate number of events from rising markets. Results fromsuch events are unlikely to be representative of all market conditions, i.e. rising, falling, and sideways,that prevailed during the 12-year sample period. To ensure a time-wise representative sample, thisstudy selects the top 10% of equity flows in each month for each class of inter-investor flows.

4.2. Abnormal returns

The event-day (t = 0) is the date corresponding to a large equity flow. Then, the average raw andabnormal stock returns are calculated for each of the 11 days in a (−5, +5) window period surroundingthe event-day.

Rt =∑N

i=1

∑Mj=1Rij

M(1)

ARt = Rt − Rm (2)

where Rij is the return on stock i on day t for investor j in a given investor class; Rt is the average returnon day t for a given investor class; Rm is the market return on day t; AR is the average abnormal returnon day t for a given investor class; N is the number of stocks traded by a given investor class on day t;M is the number of trades by a given investor class on day t.

4.2.1. Assessing the investor behavior preceding equity flowsTo investigate the behavior of investors prior to their large purchases and sales, this study defines

the pre-event cumulative average abnormal returns as follows:

CAR(−5, −1) =−1∑

t=−5

ARt (3)

The CAR(−5,−1) is the sum of the average abnormal returns from 5 days before the event to theday before the event. Purchases after significant positive pre-event CARs and sales after significantnegative pre-event CARs will provide evidence of positive feedback trading. Sales after significantpositive pre-event CARs and purchases after significant negative pre-event CARs will provide evidenceof contrarian behavior. The statistical significance is assessed through the student t-statistic of CARsfollowing Brown and Warner (1985). Positive feedback or contrarian behavior, as measured by thepre-event CARs, tends to be different among different investor classes. Hence, to assess the statisticalsignificance of the differences in CARs between investor classes, this study further conducts a t-test ofthe difference in CARs between any two investor classes.


4.2.2. Assessing the effect of equity flows on subsequent returnsThe study assesses the effect of equity flows on subsequent returns through the post-event cumu-

lative average abnormal returns, as defined below.

CAR(1, 5) =5∑

t=1

ARt (4)

The CAR(1,5) is the sum of the average abnormal returns from the day after the event to 5 days afterthe event. If purchases are followed by significant positive post-event CARs and sales are followed bysignificant negative post-event CARs, then there is evidence of price momentum. Conversely, signifi-cant negative post-event CARs following purchases and significant positive post-event CARs followingsales would be indicative of price reversals. To examine whether the event-day effect of equity flowson returns is permanent or temporary, this study uses the CARs from the event-day to 5 days after theevent-day as follows:

CAR(0, 5) =5∑

t=−0

ARt (5)

If post-event abnormal returns including the event-day abnormal returns, CAR(0,5), are significant,then that will provide evidence of persistence of the effect of trades and suggest that trades have apermanent effect on prices. On the other hand, any reversals of the event-day abnormal returns duringthe post-event period will be reflected in an insignificant CAR(0,5). Finding reversals of the event-dayabnormal returns will indicate that such effect on prices is temporary. Even in the absence of pricemomentum or reversals after the event-day, a large event-day abnormal return followed by smalland insignificant abnormal returns would suggest that trades leave a permanent trace on subsequentprices.

5. Results

5.1. Returns surrounding large purchases

Table 4 presents returns surrounding large purchases. Both raw returns (Rt) and abnormal returns(ARt) on the event-day are strongly positive for all investor classes (Panels A–F). The abnormal returnsare 1.07% (Panel A) for domestic purchases and 1.38% for foreign purchases (Panel B). The largerabnormal returns associated with purchases by foreign investors is consistent with the assertion thatpurchases by foreign investors convey positive information about the future prospects for respectivestocks. The event-day abnormal returns are larger when individual investors purchase than wheninstitutional investors purchase. Among the domestic investors, the market response to purchasesof both institutional and individual investors is just over 1%. The abnormal return associated withpurchases by foreign individual investors is 1.96%, and it is the largest among all investor classes. Thestrong positive event-day abnormal returns associated with purchases of foreign investors are largelyattributable to purchases by foreign individual investors.

The pre-event cumulative abnormal returns, CAR(−5, −1), shed light on the question of whetherpast returns influence equity flows. The pre-event CARs are large and significantly positive before largepurchases across all investor classes (Panels A–F). While previous literature shows positive feedbackbehavior of investors, what is new here is the evidence that all investor classes, foreign and domesticas well as institutional and individual, exhibit positive feedback trading on the buyside of their trades.Turning to domestic versus foreign investors, the pre-event abnormal returns are 2.31% for domesticpurchases (DP) and 1.89% for foreign purchases (FP). To assess whether this difference is statisticallydifferent, Table 5 provides the t-test for the difference in pre-event CARs between investor classes.Accordingly, the difference in pre-event CARs between domestic and foreign investors of 1.08% is sig-nificant at the 1% level, providing reliable evidence that domestic investors exhibit stronger feedbacktrading behavior than foreign investors on the buyside.

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Table 4Returns surrounding large purchases of major investor classes.

−5 −4 −3 −2 −1 0 1 2 3 4 5 Pre-event: CAR(−5, −1)

Post-event: CAR(1,5)

CAR (0,5)

Panel A: Purchases of Domestic Investors (DP) (N = 33,975)Rt (%) 0.50 0.52 0.59 0.74 1.17 1.38 0.29 0.00 0.00 0.02 −0.02

(6.30)** (6.56)** (7.34)** (9.24)** (14.62)** (17.29)** (3.67)** (0.01) (0.02) (0.31) (−0.30)ARt (%) 0.29 0.32 0.37 0.50 0.83 1.07 0.17 −0.06 −0.06 −0.05 −0.10 2.31 −0.10 0.97

(6.14)** (6.74)** (7.79)** (10.57)** (17.42)** (22.41)** (3.58)** (−1.33) (−1.23) (−1.01) (−2.01)* (21.76)** (−0.89) (8.34)**

Panel B: Purchases of Foreign Investors (FP) (N = 5675)Rt (%) 0.33 0.44 0.50 0.61 0.83 1.52 0.09 −0.01 0.02 0.02 −0.01

(4.32)** (5.83)** (6.68)** (8.15)** (10.99)** (20.13)** (1.15) (−0.15) (0.26) (0.24) (−0.18)ARt (%) 0.17 0.28 0.33 0.42 0.69 1.38 −0.04 −0.10 −0.05 −0.05 −0.08 1.89 −0.32 1.06

(2.81)** (4.69)** (5.63)** (7.17)** (11.60)** (23.27)** (−0.68) (−1.68) (−0.78) (−0.79) (−1.39) (14.27)** (−2.37)* (7.34)**

Panel C: Purchases of Domestic Institutional Investors (DCP) (N = 13,752)Rt (%) 0.38 0.44 0.44 0.52 0.83 1.26 0.22 0.01 −0.01 0.00 −0.03

(5.68)** (6.62)** (6.58)** (7.79)** (12.57)** (19.04)** (3.30)** (0.20) (−0.18) (−0.07) (−0.41)ARt (%) 0.21 0.26 0.27 0.34 0.59 1.01 0.12 −0.04 −0.06 −0.05 −0.09 1.67 −0.12 0.89

(5.10)** (6.26)** (6.37)** (8.18)** (13.91)** (24.05)** (2.94)** (−1.05) (−1.32) (−1.11) (−2.17)* (17.81)** (1.21) (8.71)**

Panel D: Purchases of Domestic Individual Investors (DIP) (N = 20,223)Rt (%) 0.59 0.58 0.69 0.89 1.39 1.46 0.34 −0.01 0.01 0.04 −0.02

(6.27)** (6.19)** (7.31)** (9.45)** (14.83)** (15.54)** (3.66)** (−0.08) (0.12) (0.47) (−0.23)ARt (%) 0.34 0.36 0.44 0.61 1.00 1.10 0.20 −0.08 −0.06 −0.05 −0.10 2.75 −0.09 1.01

(5.99)** (6.26)** (7.65)** (10.61)** (17.29)** (19.17)** (3.52)** (−1.32) (−1.05) (−0.85) (−1.71) (21.37)** (−0.63) (7.25)**

Panel E: Purchases of Foreign Institutional Investors (FCP) (N = 4260)Rt (%) 0.26 0.36 0.43 0.56 0.68 1.30 −0.02 −0.04 0.03 0.06 0.10

(3.28)** (4.41)** (5.32)** (6.99)** (8.40)** (16.13)** (−0.21) (−0.53) (0.33) (0.69) (1.20)ARt (%) 0.11 0.22 0.28 0.37 0.54 1.18 −0.12 −0.12 −0.04 −0.01 0.01 1.52 −0.26 0.90

(1.72) (3.36)** (4.15)** (5.53)** (8.19)** (17.82)** (−1.81) (−1.86) (−0.55) (−0.10) (0.16) (10.27)** (−1.86) (5.58)**

Panel F: Purchases of Foreign Individual Investors (FIP) (N = 1415)Rt (%) 0.51 0.69 0.73 0.77 1.29 2.18 0.40 0.08 0.00 −0.09 −0.35

(3.49)** (4.74)** (4.99)** (5.27)** (8.81)** (14.89)** (2.72)** (0.56) (−0.01) (−0.65) (−2.36)*

ARt (%) 0.32 0.44 0.51 0.60 1.12 1.96 0.20 −0.03 −0.07 −0.17 −0.36 2.99 −0.43 1.53(2.75)** (3.77)** (4.33)** (5.09)** (9.53)** (16.76)** (1.71) (−0.22) (−0.64) (−1.42) (−3.09)** (11.39)** (−1.64) (5.35)**

This table presents returns surrounding the largest 10% of purchases of major investor classes in the Colombo Stock Exchange from 1993 to 2004. The flows are purchases of domesticinvestors (DP), purchases of domestic institutional investors (DCP), purchases of domestic individual investors (DIP), purchases of foreign investors (FP), purchases of foreign institutionalinvestors (FCP), and purchases of foreign individual investors (FIP). Rt is the average raw stock return on day t. ARt is the market-adjusted stock abnormal return on day t. The CAR is thecumulative average abnormal return. All variables are computed in local-currency terms. All returns are continuously compounded. N is the number of observations. The t-statistics arein given in parentheses.

* Statistical significance at the 0.05 level.** Statistical significance at the 0.01 level.


Table 5Test of the difference in pre-event CARs associated with large purchases.

Investor class (1) Investor class (2) Difference in CAR(−5,−1) t[CAR(1) − CAR(2)]

Domestic Foreign 0.42 5.53**

Domestic Individual (DI) Domestic Institutional (DC) 1.08 15.17**

Domestic Individual (DI) Foreign Institutional (FC) 1.23 14.02**

Foreign Individual (FI) Foreign Institutional (FC) 1.47 10.91**

Foreign Individual (FI) Domestic Institutional (DC) 1.32 10.59**

Domestic Institutional (DC) Foreign Institutional (FC) 0.15 1.91Foreign Individual (FI) Domestic Individual (DI) 0.24 1.84

This table presents t-test of the difference in pre-event average abnormal returns [(CAR(−5,−1)] between investor classesassociated with large purchases reported in Table 4.

** Statistical significance at the 0.01 level.

Regarding the behavior of institutional versus individual investors, both event-day and pre-eventCARs corresponding to institutional investors are smaller than those associated with individualinvestors. For example, the pre-event CARs for domestic institutional purchases (DCP) are 1.67%,whereas they are 2.75% for domestic individual purchases (DIP). The pre-event CARs are 1.52% forforeign institutional purchases (FCP), while they are 2.99% for foreign individual purchases (FIP). Thet-tests reported in Table 5 show that these differences in pre-event CARs between individual and insti-tutional investors are significant at 1%, suggesting that individual investors show stronger feedbacktrading than institutional investors.

The results do not point to a discernible difference between the behavior of domestic institutionalinvestors vs. foreign institutional investors, and domestic individual investors vs. foreign individualinvestors on the buyside of trades. Although the pre-event CARs are larger for domestic institutionalinvestors compared with foreign institutional investors, and for foreign individual investors comparedwith domestic individual investors, the tests in Table 5 show that such differences are not significant.

The post-event returns in Table 4 are used to address the issue of whether purchases affect subse-quent returns. Domestic purchases (Panel A), domestic institutional purchases (Panel C) and domesticindividual purchases (Panel D) are followed by significantly positive raw and abnormal returns onday + 1, which turn insignificant thereafter. However, day + 1 returns are much smaller than the returnson any pre-event day. In the post-event period, there are non-significant negative abnormal returnssubsequent to domestic purchases. Thus, domestic purchases do not have an additional effect onreturns beyond the day after purchases. The post-event cumulative abnormal return, CAR(1,5), fol-lowing domestic purchases is −0.10% and insignificant. Post-event CARs of similar magnitude areobserved subsequent to purchases of domestic institutional and individual investors as well. Theseresults indicate that large purchases by domestic investors, both institutional and individual, do notlead to price momentum. The post-event CARs associated with purchases of foreign investors are−0.32% and significant at 5%. However, the results for foreign institutional and individual purchasesshow no significant post-event CARs. Thus, overall there is no persuasive evidence that purchases offoreign investors lead to any price momentum.

To assess whether large purchases have a permanent short-term effect on price, this study usesCAR(0,5), which is the post-event cumulative abnormal returns including the event-day. The CAR(0,5)is 0.97% for domestic purchases, 0.89% for domestic institutional purchases, and 1.01% for domesticindividual purchases. They are all significant at 1%, implying that large domestic purchases, both insti-tutional and individual, leave about 1.00% permanent effect on subsequent returns. A large componentof the event-day effect of purchases by foreign investors also remains in the price after five days. TheCARs(0,5) are 1.06%, 0.90%, and 1.53% following purchases by foreign investors, foreign institutionalinvestors, and foreign individual investors. Thus, foreign purchases also leave about a 1% permanenttrace on subsequent prices.

The major results from the buyside analysis can be summarized as follows: (1) the market responseassociated with large purchases is significantly positive for all investor classes, (2) all investor classesexhibit positive feedback trading, (2) domestic investors are stronger feedback traders than foreign


investors, (3) individual investors are stronger feedback traders than institutional investors, (4) thereis no significant difference in the behavior of domestic institutional investors vs. foreign institutionalinvestors, and domestic individual investor vs. foreign individual investors, (5) there is no persuasiveevidence of price momentum subsequent to the purchases, and (6) the purchases by all investor classeshave a permanent positive effect of prices of about 1%.

5.2. Returns surrounding large sales

Table 6 presents returns associated with the largest 10% sales of major investor classes. The inves-tigation of sales could show whether the relation between returns and sales is different from therelation between returns and purchases discussed in the previous section. Sales of domestic investors(Panel A) and foreign investors (Panel B) are associated with strongly positive event-day returns.Event-day abnormal returns are 1.22% for domestic sales and 0.44% for foreign sales. Both raw andabnormal returns are significantly positive on the day after the event as well. These results not onlyprovide powerful evidence that large sales by foreign and domestic investors do not accompany pricedeclines, but also more importantly, that such sales are associated with price increases.

Sales of domestic institutional investors (Panel C) and domestic individual investors (Panel D) alsoaccompany strongly positive abnormal returns of 1.16% and 1.25% on the event-day. Among foreigninvestors, however, only foreign individual sales (Panel F) show a reliably positive abnormal return,which is 1.98% and the largest for any investor class. Although sales by foreign institutional investors(Panel E) show no effect on event-day abnormal returns, there is a reliable 0.25% abnormal return onday +1. Thus, the strong positive event-day abnormal returns associated with sales of foreign investorsare largely attributable to sales by foreign individual investors.

On the issue of whether there is a relation between past returns and sales, the results show that allreturn measures before large sales by domestic and foreign investors are strongly positive. Domesticand foreign sales are preceded by pre-event CARs 2.45% and 1.02% respectively. Clearly, domestic andforeign investors sell after a significant run-up in stock prices, suggesting that investors are contrarianson the sellside. This result contrasts sharply with the earlier finding that investors are positive feedbacktraders on the buyside. Thus, the Sri Lankan stock market provides compelling evidence of asymmetricinvestor behavior between buy and sell trades. Further, the t-tests of the difference between pre-eventCARs associated with domestic and foreign investors, given in Table 7, suggest that they are reliablydifferent at 1% level of significance, providing evidence that domestic investors exhibit more contrarianbehavior than foreign investors on the sellside.

The pre-event CARs are 2.18% for sales of domestic institutional investors and 2.60% for sales ofdomestic individual investors, both of which are significant. They are 0.09% for sales of foreign insti-tutional investors and a large significant 3.73% for foreign individual investors. Further, as given inTable 7, the t-tests for the difference in pre-event CARs between individual and institutional investorsare all significant at 1%. These results show that individual investors exhibit more contrarian tradingthan institutional investors on the sellside. While domestic institutional investors (Panel C) also arepreceded by significant pre-event CARs, indicating contrarian behavior, foreign institutional investorsdo not exhibit such behavior on the sellside. The difference in CARs between domestic and foreigninstitutional investors is significant at 1%. Foreign individual investors tend to be more contrarianthan domestic individual investors, as indicated by the significant difference in pre-event CARs.

As far as post-event returns, other than the significantly positive raw and abnormal returns onday +1 associated with sales by domestic and foreign institutional investors, the raw and abnormalreturns are small and not significant on each of the five days following large sales. There is no evidenceof price momentum or significant price reversals following sales, except for sales by foreign individualinvestors, where about 40% of the event-day abnormal returns reverse. CAR(0,5) shows that, due tothe lack of price momentum and absence of significant reversals, a large part of event-day abnormalreturns remains at the end of five days from the event-day in sales of domestic institutional, domesticindividual, and foreign individual investors, leaving a reliable permanent effect on prices of about 1%.

The following are the major findings from the sellside analysis: (1) the event-day effect of sales by allinvestor classes, except sales by foreign institutional investors, is significantly positive, (2) all investorclasses, except foreign institutional investors, exhibit contrarian behavior, (3) domestic investors are

108L.P.Sam

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Table 6Returns surrounding large sales of major investor classes.

−5 −4 −3 −2 −1 0 1 2 3 4 5 Pre-event: CAR (−5,−1) Post-event: CAR (1,5) CAR (0,5)

Panel A: Purchases of Domestic Investors (DP) (N = 33,975)Rt (%) 0.52 0.55 0.62 0.78 1.17 1.50 0.26 0.01 0.03 0.03 −0.01

(6.48)** (6.85)** (7.71)** (9.61)** (14.49)** (18.57)** (3.18)** (0.11) (0.34) (−0.10) (−0.08)ARt (%) 0.31 0.34 0.40 0.54 0.86 1.22 0.13 −0.07 −0.05 −0.05 −0.09 2.45 −0.13 1.09

(6.34)** (7.10)** (8.23)** (11.12)** (17.73)** (25.13)** (2.71)** (−1.40) (−0.99) (−1.06) (−1.83) (22.60)** (−1.15) (9.21)**

Panel B: Purchases of Foreign Investors (FP) (N = 5675)Rt (%) 0.18 0.24 0.26 0.36 0.77 0.75 0.30 −0.06 −0.14 −0.02 −0.11

(2.51)* (3.37)** (3.54)** (4.93)** (10.75)** (10.40)** (4.19)** (−0.88) (−1.94) (−0.23) (−1.52)ARt (%) 0.06 0.13 0.15 0.19 0.49 0.44 0.20 −0.07 −0.11 −0.02 −0.12 1.02 −0.12 0.32

(1.14) (2.30)* (2.69)** (3.41)** (8.72)** (7.77)** (3.55)** (−1.29) (−1.99)* (−0.43) (−2.21)* (8.17)** (−1.06) (2.20)*

Panel C: Sales of Domestic Institutional Investors (DCS) (N = 12,375)Rt (%) 0.47 0.51 0.59 0.70 1.09 1.45 0.29 −0.01 0.08 0.06 0.00

(6.80)** (7.36)** (8.50)** (10.04)** (15.70)** (20.87)** (4.13)** (−0.10) (1.13) (0.93) (0.03)ARt (%) 0.26 0.31 0.36 0.46 0.79 1.16 0.17 −0.05 0.02 −0.01 −0.07 2.18 0.06 1.22

(6.06)** (7.21)** (8.43)** (10.82)** (18.36)** (27.05)** (4.06)** (−1.17) (0.38) (−0.28) (−1.57) (22.75)** (0.63) (11.62)**

Panel D: Sales of Domestic Individual Investors (DIS) (N = 21,876)Rt (%) 0.55 0.58 0.64 0.82 1.22 1.53 0.24 0.02 0.00 0.01 −0.01

(6.03)** (6.30)** (7.00)** (8.95)** (13.26)** (16.67)** (2.61)** (0.19) (−0.02) (0.11) (−0.16)ARt (%) 0.33 0.36 0.42 0.58 0.90 1.25 0.11 −0.08 −0.08 −0.07 −0.10 2.60 −0.22 1.03

(5.79)** (6.30)** (7.28)** (10.07)** (15.59)** (21.66)** (1.85) (−1.35) (−1.46) (−1.28) (−1.75) (20.14)** (−1.78) (7.22)**

Panel E: Sales of Foreign Institutional Investors (FCS) (N = 4015)Rt (%) −0.03 0.03 0.19 0.15 0.30 0.15 0.35 −0.04 −0.12 0.01 0.00

(−0.44) (0.47) (2.61)** (2.03)* (4.08)** (2.04)* (4.71)** (−0.54) (−1.56) (0.14) (−0.04)ARt (%) −0.10 −0.02 0.11 0.02 0.08 −0.09 0.25 −0.03 −0.08 0.02 −0.01 0.09 0.15 0.06

(−1.49) (−0.37) (1.65) (0.33) (1.30) (−1.46) (3.90)** (−0.49) (−1.17) (0.31) (−0.12) (0.63) (1.09) (0.40)

Panel F: Sales of Foreign Individual Investors (FIS) (N = 1384)Rt (%) 0.80 0.85 0.44 0.95 2.15 2.48 0.17 −0.13 −0.21 −0.09 −0.42

(5.06)** (5.35)** (2.75)** (6.00)** (13.57)** (15.71)** (1.06) (−0.83) (−1.33) (−0.60) (−2.64)**

ARt (%) 0.53 0.57 0.28 0.68 1.67 1.98 0.05 −0.19 −0.22 −0.15 −0.46 3.73 −0.97 1.01(4.60)** (4.99)** (2.45)* (5.96)** (14.51)** (17.19)** (0.40) (−1.67) (−1.88) (−1.34) (−4.02)** (14.53)** (−3.81)** (3.54)**

This table presents returns surrounding the largest 10% of sales of major investor classes in the Colombo Stock Exchange from 1993 to 2004. The flows are sales of domestic investors (DS),sales of domestic institutional investors (DCS), sales of domestic individual investors (DIS), sales of foreign investors (FS), sales of foreign institutional investors (FCS), and sales of foreignindividual investors (FIS). Rt is the average raw stock return on day t. ARt is the market-adjusted stock abnormal return on day t. The CAR is the cumulative average abnormal return. Allvariables are computed in local-currency terms. All returns are continuously compounded. N is the number of observations. The t-statistics are in given in parentheses.



Table 7Test of the difference in pre-event CARs associated with large sales.

Investor class (1) Investor class (2) Difference in CAR(−5,−1) t[CAR(1) − CAR(2)]

Domestic Foreign 1.43 19.34**

Domestic Individual (DI) Domestic Institutional (DC) 0.42 5.84**

Domestic Individual (DI) Foreign Institutional (FC) 2.51 29.15**

Foreign Individual (FI) Foreign Institutional (FC) 3.64 27.71**

Foreign Individual (FI) Domestic Institutional (DC) 1.55 12.65**

Domestic Institutional (DC) Foreign Institutional (FC) 2.09 27.17**

Foreign Individual (FI) Domestic Individual (DI) 1.13 8.79**

This table presents t-test of the difference in pre-event cumulative average abnormal returns [(CAR(−5,−1)] between investorclasses associated with large sales reported in Table 6.

** Statistical significance at the 0.01 level.

more contrarian than foreign investors, (4) individual investors are more contrarian than institutionalinvestors, (5) domestic institutional investors are more contrarian than foreign institutional investors,(6) foreign individual investors show more contrarian behavior than domestic individual investors,(7) there is no persuasive evidence of price momentum subsequent to the sales, (8) large sales have apermanent positive effect of prices of about 1% for all the investor classes, except foreign institutionalinvestors, and (9) foreign institutional investors do not exhibit any discernible behavior either beforeor after sales.

5.3. Returns surrounding large purchases between investor classes

Table 8 reports the event-study results relating to inter-investor purchases.12 These are flows repre-sented in each of the 16 inside cells in the turnover matrix. These inter-investor flows can be examinedfrom the perspective of the buyside investor or the sellside investor. This study looks at the resultsfrom the buyside investor. The main interest in this analysis is to see if the findings from major investorclasses, discussed earlier, are different in inter-investor class trades.

5.3.1. Purchases of domestic institutional investors from investor classesPanel A of Table 8 shows the CARs when domestic institutional investors purchase from investor

classes.13 The event-day abnormal returns are strongly positive when domestic institutional investorspurchase from all investor classes, except from foreign institutional investors. The abnormal returnsare 1.00% in purchases from domestic institutional investors (DCDC), 1.22% in purchases from domesticindividual investors (DCDI), and 1.37% in purchases from foreign individual investors (DCFI). Althoughthe largest purchases of domestic institutional investors involve foreign institutions on the sell-side, purchases from foreign institutional investors (DCFC) are not associated with significant marketreturns.

The pre-event CARs show that domestic institutional investors act as positive feedback traderswhen they purchase from domestic institutions, domestic individuals, and foreign individuals. It ispossible to discern an interesting order to the pre-event returns associated with purchases by domes-tic institutional investors. When domestic institutions purchase, the magnitude of pre-event stockabnormal returns rank in the following ascending order: foreign institutions (−0.40%), domestic insti-tutions (1.59%), domestic individual investors (2.09%), and foreign individual investors (2.31%). Thisorder of returns suggests that domestic institutional investors exhibit the strongest feedback trad-ing when they purchase from foreign individual investors followed by their purchases from domesticindividual investors, and domestic institutional investors.

In trades with domestic institutional, domestic individual, and foreign institutional investors, thepost-event CARs remain small and insignificant, suggesting that there is no price momentum. There is

12 In the interest of efficiency, this table reports the CARs only. The detail tabulations of results are available from the author.13 The purchases of a particular investor-class also include purchases from the same investor-class.


Table 8Returns surrounding purchases between investor classes.

Investor class (buyer: seller) Event-day: ARt Pre-event: CAR(−5,−1) Post-event: CAR(1,5) CAR(0,5) N

Panel A: Purchases of Domestic Institutional InvestorsDCDC 1.00 1.59 0.00 1.01 4745

(21.21)** (15.04)** (0.04) (8.69)**

DCDI 1.22 2.09 −0.23 0.98 7139(21.71)** (16.67)** (−1.87) (7.16)**

DCFC −0.14 −0.40 0.35 0.20 1373(−1.57) (−1.94) (1.69) (0.91)

DCFI 1.37 2.31 −0.81 0.56 495(10.17)** (7.69)** (−2.69)** (1.70)

Panel B: Purchases of Domestic Individual InvestorsDIDC 1.17 2.82 0.20 1.36 5883

(20.23)** (21.88)** (1.54) (9.67)**

DIDI 1.20 2.93 −0.19 1.01 11979(17.41)** (19.01)** (−1.23) (5.98)**

DIFC −0.25 0.53 0.11 −0.14 1708(−3.08)** (2.94)** (0.58) (−0.72)

DIFI 2.37 4.77 −1.10 1.27 653(14.42)** (12.96)** (−3.00)** (3.15)**

Panel C: Purchases of Foreign Institutional InvestorsFCDC 1.52 1.41 −0.19 1.33 1282

(14.44)** (6.01)** (−0.80) (5.16)**

FCDI 1.24 1.98 −0.30 0.94 2056(16.16)** (11.49)** (−1.76) (5.00)**

FCFC 0.28 −0.14 −0.20 0.08 734(2.28)* (−0.50) (−0.73) (0.26)

FCFI 1.77 3.89 −0.88 0.89 188(6.40)** (6.28)** (−1.42) (1.32)

Panel D: Purchases of Foreign Individual InvestorsFIDC 1.70 2.28 −0.42 1.28 465

(11.92)** (7.16)** (−1.32) (3.66)**

FIDI 2.53 4.10 −0.66 1.86 702(15.41)** (11.18)** (−1.81) (4.64)**

FIFC 0.20 0.51 0.61 0.81 200(0.71) (0.81) (0.96) (1.17)

FIFI 3.67 3.83 −1.42 2.25 48(5.87)** (2.74)** (−1.02) (1.47)

This table presents returns surrounding the largest 10% of purchases between major investor classes in the Colombo StockExchange from 1993 to 2004. The investor classes are domestic institutional investors (DC), domestic individual investors (DI),foreign institutional investors (FC), and foreign individual investors (FI). The variables for inter-investor purchases are as definedin Table 2. ARt is the market-adjusted stock abnormal return on day t. The CAR is the cumulative average abnormal return. Allvariables are computed in local-currency terms. All returns are continuously compounded. N is the number of observations.The t-statistics are in given in parentheses.


a significant reversal following the purchases from foreign individual investors (DCFI). The CAR(0,5) is1.01% and 0.98% in purchases from domestic institutional investors (DCDC) and domestic individualinvestors (DCDI), indicating that purchases of domestic institutional investors from domestic institu-tions and domestic individuals appear to have about 1.00% permanent positive effect on prices. Thepurchases from foreign institutional and foreign individual investors do not leave a permanent effect


on subsequent prices. In fact, about 59% of the event-day positive abnormal returns of 1.37% associatedwith purchases from foreign individual investors (DCFI) reverses during the post-event period.

5.3.2. Purchases of domestic individual investors from investor classesPanel B of Table 8 reports returns surrounding purchases of domestic individual investors from

investor classes. Accordingly, event-day abnormal returns are significantly positive when domes-tic individual investors purchase from all investor classes. The largest abnormal returns of 2.37% arefound when they purchase from foreign individual investors (DIFI). The pre-event CARs are also reliablypositive when domestic individual investors purchase from all investor classes, suggesting positivefeedback behavior by domestic individual investors, irrespective of the investor class on the sellside.When domestic individuals purchase, the pre-event CARs rank in the following ascending order: for-eign institutions (0.53%), domestic institutions (2.82%), domestic individual investors (2.93%), andforeign individual investors (4.77%). This pattern of pre-event CARs in purchases of domestic individ-ual investors is identical to the pattern observed with regard to purchases of domestic institutionalinvestors. Hence, domestic investors, both institutional and individual, exhibit the strongest feedbacktrading behavior when they purchase from foreign and domestic individual investors.

There is no evidence of momentum in post-event CARs. However, there is a 46% reversal of theevent-day abnormal returns associated with their purchases from foreign individual investors (DIFI).The large and significant CAR(0,5) in domestic individual purchases from domestic institutions (1.36%),domestic individuals (1.01%), and foreign individual investors (1.27%) indicate that these purchaseshave a permanent positive effect on prices. Such an effect is not present in their purchases from foreigninstitutional investors (DIFC).

5.3.3. Purchases of foreign institutional investors from investor classesPanel C of Table 8 gives results relating to purchases of foreign institutional investors from investor

classes. There are positive and statistically significant event-day abnormal returns associated withtheir purchases from all investor classes. The pre-event CARs are 1.41% in purchases from domes-tic institutional investors (FCDC), 1.98% in purchases from domestic individual investors (FCDI), and3.89% in purchases foreign individual investors (FCFI). This evidence suggests that foreign institutionalinvestors show positive feedback trading behavior when they purchase from domestic institutions,domestic individuals, and foreign individuals. However, trades between foreign institutional investors(FCFC) are not correlated with the recent return performance of stocks. Perhaps, such trades are drivenmore by asset allocation decisions than stock selection. As with domestic institutional investors, thestrongest positive feedback trading occurs when they purchase from individual investors, both foreignand domestic.

The post-event CARs show no evidence of price momentum or significant reversals of the positiveevent-day returns. The CAR(0,5) is 1.33% and 0.94% in purchases from domestic institutional andindividual investors. Thus, there is reliable evidence that purchases of foreign institutional investorsfrom domestic investors, both institutional and individual, tend to leave a permanent effect in prices.

5.3.4. Purchases of foreign individual investors from investor classesPanel D of Table 8 presents returns surrounding purchases of foreign individual investors from

investor classes. The event-day abnormal returns are large and reliably positive when foreign individ-ual investors purchase from all investor classes, except foreign institutional investors. These abnormalreturns are very large ranging from 1.70% in purchases from domestic institutional investors (FIDC)to 3.67% in purchases from foreign individual investors (FIFI). Similar to the results relating to foreigninstitutional investors, there are reliably positive and large pre-event CARs. They are 2.28% in purchasesfrom domestic institutional investors (FIDC), 4.10% in purchases from domestic individual investors(FIDI), and 3.83% in purchases from foreign individual investors (FIFI). However, their purchases fromforeign institutional investors (FIFC) do not precede or coincide with significant abnormal returns.Regardless of the seller, there is no evidence of price continuations following their purchases. TheCARs(0,5) associated with purchases from domestic institutional and individual investors are 1.28%and 1.86% respectively, suggesting a permanent price effect.


The major findings from inter-investor purchases can be summarized as follows: (1) purchases ofall investor classes are associated with economically and statistically significant positive event-dayabnormal returns, except when they purchase from foreign institutional investors;14 (2) All investorclasses are positive feedback traders on the buyside, except when they purchase from foreign insti-tutional investors. This also implies that all investor classes are contrarian traders on the sellside,except foreign institutional investors. This result is an important exception to the earlier finding thatall investors are positive feedback traders on the buyside. The recent return performance does notinfluence foreign institutional investors’ large trades with any of the four counter parties; (3) Thereis no reliable evidence of price momentum; (4) Purchases by all investor classes have a noticeablepermanent price effect when such purchases are from domestic investor classes. In the trades wherethere is no permanent effect, the seller is a foreign investor class.15

6. Conclusions

Using a unique data set from the emerging market of Sri Lanka, this study investigates the relationbetween returns and equity flows representing domestic institutional investors, domestic individualinvestors, foreign institutional investors, and foreign individual investors with the primary objectiveof understanding the buyside and sellside behavior of different investors. This study dissects the entireturnover matrix in the market into 16 possible inter-investor trades and examines the dynamics ofthe relation between stock returns and flows. The relation between returns and flows is investigatedusing an inter-day event-study approach.

The empirical results on the issue of the relation between returns and flows produce some remark-able evidence on investor behavior. The behavior of investors varies according to whether the trade ison the buyside or the sellside. Except when the seller is a foreign institutional investor, all four investorclasses show strong evidence of positive feedback trading when they purchase and contrarian tradingwhen they sell. Thus, there is strong evidence of asymmetric investor behavior on the buyside and thesellside. Foreign institutional investors behave differently from all other investors in that their salesare not influenced by the recent return performance of stocks. This finding suggests that their salesdecisions are driven by other factors, such as changes in country, and asset allocation decisions.

The relative magnitude of positive feedback and contrarian trading differs between differentinvestor classes. Domestic investors exhibit more feedback trading as well as more contrarian behaviorthan foreign investors, individual investors show more feedback and more contrarian behavior thaninstitutional investors, domestic institutional investors are more contrarian than foreign institutionalinvestors, and foreign individual investors are more contrarian than domestic individual investors.These differences can reflect the relative information advantages of a given investor class. The returnpreceding purchases by more-informed investors are likely to be less than the returns precedingpurchases by less-informed investors. From this asymmetric information perspective, on the buy-side, foreign investors are more informed than domestic investors, and institutional investors aremore informed than individual investors. The returns preceding sales by more-informed investors arelikely to be larger than returns preceding sales by less-informed investors. This argument impliesthat domestic investors are more informed than foreign investors, individual investors are moreinformed than institutional investors, domestic institutional investors are more informed than foreigninstitutional investors, and foreign individual investors are more informed than domestic individualinvestors.

The study also finds that both purchases and sales of all investor classes are associated with reliablypositive concurrent abnormal returns, except when foreign institutional investors sell. It is plausiblethat the positive information or price effect contained in purchases dominate the potentially negativeinformation or price effect associated with sales, leaving a positive effect on balance. There is no reliableevidence of price momentum or reversals subsequent to the purchases and sales by any investor class.

14 There are statistically significant event-day abnormal returns associated with purchases from foreign institutional investorsin the case of DIFC and FCFC. But they are economically small.

15 Only exception is DIFI.


Both purchases and sales leave a small permanent positive effect on prices, except when foreigninstitutional investors sell. Sales by foreign institutional investors do not cause any discernible priceeffect subsequently.

Acknowledgements

I am grateful for comments from participants and discussants at meetings of the Financial Man-agement Association, Global Finance Association, and the Southern Finance Association, and seminarparticipants at the Central Bank of Sri Lanka. I wish to thank Stephen Ferris (editor) and the referee foruseful suggestions. I also thank Lalin Paranavitana, Rajeeva Bandaranaike, Dayanitha Jayakody, andTushara Jayaratne of the Colombo Stock Exchange for providing the data. All errors are my own.

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Documents

Asymmetric investor behavior between buyside and sellside: Evidence from investor classes in the Sri Lankan stock market