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The relationships among three major institutionalinvestors, general individual investors, and the stockmarketCho-Min Lin a , Bor-Yi Huang b , Wan-Hsiu Cheng c & Pei-Shan Wu da Department of Finance , Ling Tung University , 1, Lingtung Road, Nantun 408, TaichungTaiwan , R.O.C. E-mail:b Department of Finance and Banking , Shih-Chien University , 70, Ta-Chih St. Taipei 104Taiwan , R.O.C. E-mail:c Department of Finance , Asia University , 500 Liou-Fong Road, Wufong 413, TaichungCounty Taiwan , R.O.C. E-mail:d Department of Finance , Ching Yun University , Taiwan , R.O.C. E-mail:Published online: 14 Jun 2013.
To cite this article: Cho-Min Lin , Bor-Yi Huang , Wan-Hsiu Cheng & Pei-Shan Wu (2007) The relationships among threemajor institutional investors, general individual investors, and the stock market, Journal of Statistics and ManagementSystems, 10:1, 87-102, DOI: 10.1080/09720510.2007.10701241
To link to this article: http://dx.doi.org/10.1080/09720510.2007.10701241
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The relationships among three major institutional investors, generalindividual investors, and the stock market
Cho-Min Lin ∗
Department of FinanceLing Tung University1, Lingtung RoadNantun 408, TaichungTaiwan, R.O.C.
Bor-Yi Huang †
Department of Finance and BankingShih-Chien University70, Ta-Chih St.Taipei 104Taiwan, R.O.C.
Wan-Hsiu Cheng ‡
Department of FinanceAsia University500 Liou-Fong RoadWufong 413, Taichung CountyTaiwan, R.O.C.
Pei-Shan Wu §
Department of FinanceChing Yun UniversityTaiwan, R.O.C.
∗E-mail: [email protected]†E-mail: [email protected]‡E-mail: [email protected]§E-mail: [email protected]
——————————–Journal of Statistics & Management SystemsVol. 10 (2007), No. 1, pp. 87–102c© Taru Publications
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Abstract
This study investigates the correlation among the three institutional investors, generalindividual investors, and the stock market using the multivariate GARCH model. We alsoanalyze the effect of releasing the restriction of foreign investment. The empirical resultsreveal that trading behavior of foreign institutional investors holds a crucial influence ondomestic dealers and general individual investors, and the counter-trading phenomenonof foreign institutional investors and domestic institutional investors is due to differentinvestment judgments. A verification of the impulse response equation reveals institutionalinvestors perform at a faster information transmission effect. Overall, a full opening up offoreign capital might not be as powerful as expected.
Keywords : Three major institutional investors, general individual investors, multivariate GARCH
model.
1. Introduction
For many years, government in Taiwan follows the principle of“looseness in business and tightness in finance” and adopts many policies,such as the allowance of composite dealers to set up self-operating sectionsin 1989, the introduction of foreign professional institutional investors(QFIIs) to invest in Taiwan in 1990, the approval of 11 new applicationsof securities investment trust corporations in 1993, a full opening up offoreigners to invest in Taiwan since March 1996, allowing commissionedinvestment business by securities consultation and investment institutessince October 19, 2000, and fully release the investment restriction toforeign capitals in January 1, 2001. All these policies are released the re-striction to institutional investors, which holds a pool of funds, lots sourcesof usable and up to date information, professional knowledge and sensi-tive operation technologies, and lead to strength the position of domesticdealers, domestic institutional investors (including four major local funds,i.e., Government employees’ retirement fund, post office reserve fund,labor retirement fund, and labor insurance fund), and foreign institutionalinvestors, so called three major institutional investors. Turning now to theinvestment structure of Taiwans stock market is still primarily composedby individual investors (see Table 1).
Principally, individual investors are blind and easily influencedby market messages due to insufficient professional training, inferior
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RELATIONSHIPS AMONG THREE INVESTORS 89
operation techniques, and biased information judgment, causing not onlyindividual investment failure, but also abnormal and irrational volatilityin the market.
Table 1The trading values of institutional investors and individualinvestors
Domestic institutional Foreign Domesticinvestors & dealers institutional investors individual investorsValues % Values % Values %
1992 4, 527.2 3.6 316.3 0.1 119, 538.0 96.11993 9, 932.4 5.4 896.9 0.5 174, 151.1 94.11994 22, 609.9 5.8 2, 644.6 0.7 364, 152.4 93.51995 13, 783.1 6.7 2, 839.9 1.4 189, 400.2 91.91996 22, 654.3 8.6 5, 567.3 2.1 234, 451.6 89.31997 56, 948.6 7.6 12, 890.2 1.7 684, 282.1 90.71998 51, 442.5 8.6 9, 647.5 1.6 534, 805.1 89.71999 55, 204.9 9.4 14, 201.1 2.4 520, 431.8 88.22000 63, 065.1 10.3 22, 221.5 3.6 528, 553.2 86.12001 35, 694.1 9.7 21, 688.0 5.9 310, 815.4 84.42002 48, 681.1 11.1 28, 975.7 6.6 361, 052.2 82.3
NOTES 1. The unit of values are NTD 10 million dollars2. The percentages (%) are trading values to market total trading values3. Sources: Taiwan Stock Exchange Corporation
Earlier researches are listed in the following. Based on the efficientmarket hypothesis, Fama (1970) proposes that block trading cannot affectstock prices under an efficient market, where stock prices react properlyto new market messages. However, Kraus and Stoll (1972), Close (1975),and Shleifer (1986) et al. recognized that block trading does influenceand confine the stock price and makes investors re-evaluate the stockprice. The same results appear in Chan and Lakonishok (1993), Bekaertand Harvey (1997), Choe et al. (1999), Karolyi (1999), and Wang andShen (1999) also suggest that the foreign capital can affect the stockmarket. On the contrary, some papers suggest that the block trading offoreign capital does not increase the volatility of stock market. Aggarwaland Chen (1990) find that FIs has just a little or no influence on the stockmarket at all. This is the discussion point that we analyze in this paper,Taiwans government release the investment restriction of foreign capitalsgradually, and fully open in January 1, 2001. We wonder that if the policy
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90 C. M. LIN ET AL.
of release the investment restrictions will change the dynamic relationshipto the stock market.
Further, taking a look into the investment strategies of the institu-tional investor, previous studies suggest that the strategies are signifi-cantly influenced by market trends and the other institutional investorsbehavior. That is to say, the institutional investors strategies can be classi-fied into two categories, namely positive feedback trading (e.g., De Long,Shleifer, Summers and Waldmann (1992)) and herding (e.g., Scharfsteinand Stein (1990)). The former strategy means that institutional investorsbuy when a stock goes up and sell when a stock goes down. As De Longet al. (1992) point out a market trend analysis strategy can be the focusfor institutional investors to investment. The latter one, herding, meansthat institutional investors are influenced by other institutional investors’trading behaviors. Scharfstein and Stein (1990) even consider that herdingbehaviors sometimes violate the fundamental market trend. As noticed,the behaviors of institutional investors and market trends are closelyrelated, therefore, Taiwans government tends to stabilize the market by therelative rational investment behaviors of institutional investors accordingto they held abundant capital and remarkable resources in making theright investment via a proper utilization of investment strategies, analysisof global economic factors, and global market trends. Moreover, institu-tional investors usually take longer investment strategies than individualinvestors, and the operations is positive for the long-term developmentsof the local stock market structure and enhance the market efficiency.
Relative to previous researches, this study fully discuss the rela-tionship among three major institutional investors, general individualinvestors and the market. Most studies aimed on the correlation betweentwo parties, for example, the relationship between institutional investorsand market, the relationship among these institutional investors, or therelationship between foreign investments and market. Therefore, it isneeded to discuss these investors simultaneously for deeply realizing thedynamic relationships, and unlike traditional models, the multivariateGARCH are used in this model. In the following, fully release the restric-tion of foreign capitals is another point in this paper. As shown in Table 1,the trading values of foreign institutional investors grow in these years,and individual investors in Taiwan market are highly follow the behaviorsof foreign investment. Proponents of lifting the restrictions point out theirpositive results like their stabilizing and demonstration effects, claiming
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RELATIONSHIPS AMONG THREE INVESTORS 91
that liberalizing can consolidate the structure of the stock market andimprove its efficiency. Opponents to the lifting of restrictions assert thatalthough the liberalization of multinational funds is an important partof internationalization and overall liberalization, once a country has anoverinvestment of multinational funds, and it is more vulnerable to theswings of other stock markets. We set the dummy variable to investigateif the exogenous shocks do affect the relationship. The third point inthis paper is the impulse response function modified by the multivariateGARCH model, which can contain the characteristics of time varyingvariance. Thus, in this part, we can analyze that if factors are affectedby the shock of another factor, and also observe the influence size and thepersistence. Final, the results can be the target of executing liberalizationpolicy, and the government can predict the following responses of eachsection.
The remainder of this article is organized as follows: Section 2describes the methodology and data; section 3 analyzes the empiricalresults; and the final section summarizes the conclusions that are drawn.
2. Methodology method
The traditional econometrics models assume that the variances of theerror term are always constant, however most financial series data exhibitthe characteristics of autocorrelation and volatility clustering. To counterthese characteristics, Engle (1982) and Bollerslev (1986) proposed theARCH (Autoregressive Conditional Heteroskedasticity) and the GARCH(Generalized ARCH) models, allowing the variance varies over time. Thisstudy adopts the multivariate GARCH model to evaluate the correlationamong the three major institutional investors, the general individualinvestors and the stock market after governments opening-up policies forforeign capital to invest in local stocks. The variables of R1,t, R2,t, R3,tand R4,t represent the changing rate of net investments of the foreigninstitutional investors, the domestic institutional investors, dealers and theindividual investors, and the variable R5,t means the stock index returns1.Moreover, the term D∗ is the dummy variable of a full opening-up offoreign investment on January 1, 2001; D∗ is equal to 1 when the dateis later than 1 January 2001, and it is 0, otherwise. The mean equations can
1All variables are stationary under unit root test.
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92 C. M. LIN ET AL.
be described as followed:
R1,tR2,tR3,tR4,tR5,t
=
α10
α20
α30
α40
α50
+
α11 α12 α13 α14 α15 α16
α21 α22 α23 α24 α25 α26
α31 α32 α33 α34 α35 α36
α41 α42 α43 α44 α45 α46
α51 α52 α53 α54 α55 α56
R1,t−1
R2,t−1
R3,t−1
R4,t−1
R5,t−1
D∗
+
ε1,tε2,tε3,tε4,tε5,t
(1)
where [ε1,tε2,tε3,tε4,tε5,t]′|Ωt−1 ∼ N(0, Ht). The term Ωt−1 means that theinformation set at time t − 1. The conditional variance Ht is reportedbelow:
Ht = C′C +5
∑k=1
A′kεt−1ε′t−1 Ak +
5
∑k=1
G′k Ht−1Gk . (2)
In the following, we deeply describe the conditional variance Ht,
where Ht =
h11,t . . . h15,t...
. . ....
h51,t . . . h55,t
, the term C is the triangular ma-
trix
C =
c11 . . . c15
0. . .
...0 0 c55
, moreover, the matrix A and G are
generalized setting according to the theory, for example A1 =
a1,11 0. . .
0 a1,55
. . . A5 =
0 0. . .
0 a5,55
, and the setting of G is the
identical as A. The advantages of this model lie in that the setting ofthe model implies that the elements in every covariance matrix are theequations of their correlated historical data. Finally, this study adoptsMaximum Likelihood Estimation (MLE) approach to estimate the coefficientsin the model, and the simplified logarithm likelihood function can beillustrated as follows:
L(θ) = −12
T
∑t=1
(ln |Ht|+ε′tH−1t εt), (3)
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RELATIONSHIPS AMONG THREE INVESTORS 93
where θ represents the parameter vector to be estimated and T representsthe number of observations.
3. Empirical results
3.1 Descriptive statistics analysis
All of the data are obtained from the Taiwan Economic JournalData Bank (TEJ). The empirical periods are from August 1, 1995 toDecember 31, 2002 and totally 2005 trading days are in this study. The basicdescriptive statistics are reported on Table 2 and Figure 1 to 4 portray thenet investments of the three major institutional investors and individualinvestors relative to stock index.
Table 2Descriptive statistics of trading behavior of investors andstock index
Mean S.D. Max. Min.Total PeriodForeign institutional investors 449.28 2306.33 17582.00 −15460.00Domestic institutional investors −74.03 1296.08 10070.00 −6764.00Dealers −20.90 745.61 4219.00 −3831.00General individual investors 54.41 3070.91 28332.00 −33001.00Stock index 6717.21 1588.82 10202.20 3446.26Period 1Foreign institutional investors 367.31 1789.21 12280.00 −15460.00Domestic institutional investors −104.41 1338.47 10070.00 −6764.00Dealers −42.44 739.45 4219.00 −3831.00General individual investors 47.35 3298.29 28332.00 −33001.00Stock index 7266.81 1412.48 10202.20 4503.37Period 2Foreign institutional investors 696.04 3410.56 17582.00 −10345.00Domestic institutional investors 17.41 1155.62 6453.00 −4908.00Dealers 43.93 760.95 4021.00 −3256.00General individual investors 75.66 2254.73 7474.00 −7314.00Stock index 5062.91 686.55 6462.30 3446.26
NOTES 1. Except for the stock index, all variables are valued in million NT dollars2. Total period is from August 1, 1995 to December 31, 2002; the period
1 ranges from August 1, 1995 to December 31, 2000 and the period 2ranges from January 1, 2001 to December 31, 2002
From Table 2, the net trading values of domestic institutional in-vestors increase from −104.41 million to 17.41 million, and domesticdealers shifted their investment strategies from −42.44 million to 43.93
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94 C. M. LIN ET AL.
million, while the trading values of individual investors increase from47.35 to 75.66 million. We also observe that the net trading values offoreign institutional investors is 367.31 million on average in period 1which before the fully opening of foreign investments, and 696.04 millionin period 2 which after the fully opening of foreign investments. Thestandard variation of foreign institution investors in period 2 is muchhigher than the standard variation in period 1. It property indicates thatthe effects of the new regulations, which the trading values of foreign in-stitutional investors is much flexibility. Otherwise, the standard variationof stock index is lower in period 2, from this viewpoint, the liberalizingpolicies lead to reducing the variance of the market, and the results areconsistent with Bekaert and Harvey (1997). Deeply analyses are drawn inthe next section.
Figure 1The net investment of foreign institutional investors (left-sidescale and the dotted line) and stock index (right-side scale and thesolid line)
Figure 2The net investment of domestic institutional investors (left-sidescale and the dotted line) and stock index (right-side scale and thesolid line)
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RELATIONSHIPS AMONG THREE INVESTORS 95
Figure 3The net investment of dealers (left-side scale and the dotted line)and stock index (right-side scale and the solid line)
Figure 4The net investment of general individual investors (left-side scaleand the dotted line) and stock index (right-side scale and the solidline)
3.2 Multivariate GARCH(1, 1) model
The empirical results of the multivariate GARCH model are listed inTable 3.
The correlation between institutional investors and general indi-vidual investors reveals that the behavior between foreign and domes-tic investors is significantly and mutually related. Dealers and generalindividual investors are positively correlated to the trading of foreigninstitutional investors, which estimation parametersα13 andα14 are 0.4517and 0.0100 respectively. This implies that the expectation of stocks surgingfrom dealers and general individual investors who place purchase ordersat period t, encourage the foreign institutional investors to follow at periodt + 1. The parameter α12 of −0.0265 at the 5% significant level indicatesthat both domestic and foreign institutional investors significantly stand
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at counter-trading. In addition, both α23 and α24 are positive and showthe significant impact of dealers and general individual investors ondomestic institutional investors, respectively. As for parameters α31, α32
and α34, only α31 is significant at the 1% level, which implies the dealer’strading tracks the behavior of foreign investment, so does to the individualinvestor (indicated by α41). In sum, the influence of foreign capital on bothdomestic dealers and general individual investors is crucial and henceplay a key role in the domestic stock market.
Table 3Empirical results of the multivariate GARCH
Foreign Domestic General Stock
Institutional institutional Dealers individual index
investors investors investors
α10 5.2415‡ α20 6.9343‡ α30 5.9144‡ α40 −0.0203 α50 −3.0704‡
α11 0.4517‡ α21 −0.0887‡ α31 0.0389‡ α41 0.0119‡ α51 0.4876‡
α12 −0.0265† α22 0.2752‡ α32 0.0109 α42 0.0005 α52 −0.1915‡
α13 0.0275‡ α23 0.0511‡ α33 0.2318‡ α43 0.0006 α53 0.1080‡
α14 0.0100? α24 0.0126† α34 −0.0000 α44 0.9922‡ α54 −0.0584‡
α15 0.0115‡ α25 0.0276‡ α35 0.0221‡ α45 −0.0030‡ α55 0.0317
α16 0.0343‡ α26 0.0169† α36 0.0008 α46 −0.0011 α56 −0.0614
Q(20) 80.22‡ Q(20) 41.06‡ Q(20) 35.06? Q(20) 76.43‡ Q(20) 20.03
Q2(20) 19.09 Q2(20) 5.78 Q2(20) 4.92 Q2(20) 19.99 Q2(20) 27.49
Likelihood function value 11115.29
NOTE. ?, †, ‡ denote significance at 10%, 5% and 1% levels
Furthermore, the stock index returns equation in table 3 find that theforeign investments play a leading role in Taiwan stock market insteadof domestic institutional investors, as shown in α51 and α52. Generallyspeaking, the positive investment in the stock market will lead the marketupward, and let the markets downward adversely from negative invest-ment. However, the stock price trends to the trading behavior of foreigninvestments. Moreover, dealers mainly follow the foreign institutionalinvestors and result in similar performance as the foreign investors do.Interestingly, although the sum of trading values of the general individualinvestors dominate other investors in Taiwan market, they could hardlyaffect this market due to the divergent recognition and relatively smalltrading volume in the market.
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RELATIONSHIPS AMONG THREE INVESTORS 97
This study also investigates the impacts of the government’s opening-up policy of foreign capital on a number of variables. Parameters α16,α26, α36, α46 and α56 represent the impacts of releasing the restrictionsof foreign capitals on foreign institutional investors, domestic institutionalinvestors, dealers, and general individual investors, respectively, whereonlyα16 andα26 reveal a significantly positive correlation. This shows thatthe opening-up policy of foreign capital was encouraging for domestic andforeign institutional investors, but no significant impact was detected ondealers and general individual investors nor did it help create a surge inthe stock market. That is, a full opening of foreign capital did not causea significant influence on the system risk of the domestic stock market,which implies that the impulse of a full opening of foreign capital mightnot be as significant as expected. Previous stages of open policies mightbe enough to satisfy foreign institutional investors.
3.3 Impulse response
This study also utilizes the impulse response approach to analyze theinteraction between the three major institutional investors and general in-dividual investors after the multivariate GARCH model analysis. Figures5 to 9 portray the results of the impulse responses. Solid lines represent thevolatility of foreign capital and dotted lines represented the volatility ofdomestic institutional investors, dealers, and general individual investors.
Figure 5Impulse response to foreign institutional investors. Line 1 to line 5reported as foreign institutional investors, domestic institutionalinvestors, dealers, general individual investors and stock indexrespectively
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98 C. M. LIN ET AL.
Figure 6Impulse response to domestic institutional investors. Line 1 toline 5 reported as foreign institutional investors, domestic insti-tutional investors, dealers, general individual investors and stockindex respectively
Figure 7Impulse response to dealers. Line 1 to line 5 reported as foreigninstitutional investors, domestic institutional investors, dealers,general individual investors and stock index respectively
As revealed in Figures 5 and 9, the impulse response of a variety ofvariables themselves is most powerful, i.e., the most powerful responseoccurred at period 1 and decreased gradually until a complete response atperiod 7. Figures 5 to 7 reveal a positive effect of mutual impulse responsesamong institutional investors. The impulse response of general individualinvestors to foreign institutional investors exhibits a positive response, but
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RELATIONSHIPS AMONG THREE INVESTORS 99
the response to domestic institutional investors and dealers is negative.Figure 8 portrays that except for foreign institutional investors, other in-stitutional investors led negative response to general individual investors.Figure 9 depicts a positive response of institutional investors as well asgeneral individual investors to the capital market.
Figure 8Impulse response to general individual investors. Line 1 to line 5reported as foreign institutional investors, domestic institutionalinvestors, dealers, general individual investors and stock indexrespective
Figure 9Impulse response to stock index. Line 1 to line 5 reported asforeign institutional investors, domestic institutional investors,dealers, general individual investors and stock index respectively
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100 C. M. LIN ET AL.
To sum up, the findings show that the mutual impulse responses amongthe three major institutional investors are fast and consistent, which mightbe caused by the close relation among the institutional investors and theprofessional analytical resources they own. However, the results revealthat the stock market in Taiwan is not efficient. The market does notreact to all information immediately, including the impulses caused byinstitutional investors or the market itself. It takes many days to digest theimpulses and reveal the real impacts on the market.
4. Conclusion
This study utilizes the multivariate GARCH model to investigatethe correlation among the three institutional investors, general individualinvestors, and the stock market. The effect of executing liberalizationpolicy for foreign investment is also examined in this empirical study. Theempirical results reveal that there exists a straightforward correlationbetween the trading behaviors of foreign institutional investors and localdealers and general individual investors. Local institutional investorsand foreign institutional investors exhibit counteracting relations, whichmight be caused by different investment judgments. In addition, tradinginformation of foreign institutional investors holds a crucial influence ondomestic dealers and general individual investors, especially when thestock market encounters a downturn or a lack of confidence. Generalindividual investors often follow and imitate the institutional investorsand caused an interacting effect. The empirical results also reveal that theinvestment strategies of institutional investors closely correspond to stockreturns. Trading of institutional investors holds economies of scale anddiffused investment risks that function as a predictive index for generalindividual investors. It is interesting to find out that the sum of tradingvalues of the general individual investors dominate other investors inTaiwan market, however, they could hardly affect this market due to thedivergent recognition and relatively small trading volume in the market.
Further, empirical results in impulse response functions reveal thatthe stock market in Taiwan is not efficient. The mutual impulses betweeninstitutional investors and individual investors could be completely reactwithin ten periods. However, the impulse response speed of general indi-vidual investors is not as fast as institutional investors. The reasons mightbe that institutional investors possess professional analytical resourcesand the close interaction between institutional investors enhances market
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RELATIONSHIPS AMONG THREE INVESTORS 101
information transmission. Even though, this may be true the market didnot efficiently and immediately respond to the impulses raised by themarket, nor institutional investors. Finally, even though a full openingof foreign capital did not change the system risk of the domestic stockmarket significantly, the government should not omit the role of foreigninvestments and the herbing strategies of domestic investors. All theresults above would provide a well experience to the emerging marketsfor executing the liberalizing policies in the future.
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Received October, 2005
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