How foreign investors influence stock markets? The Saudi Arabian experience

ABSTRACT

This paper investigates the impact of foreign institutional investors on valuation, liquidity and volatility in the Saudi stock exchange for the post-liberalization period. Saudi regulators allowed the foreign investment community to invest in the Tadawul All Share Index (TASI) in June 2015. Firstly, the paper finds a positive change in abnormal returns in the three-year post-liberalization period compared to the three-year non-liberalization period (pre-period), suggesting that the entry of qualified foreign institutional investors (QFIIs) benefited security valuation. Further, the higher valuation result is consistent with the prediction of standard international asset pricing models, that stock market liberalization may reduce the liberalizing country’s cost of equity capital by allowing for risk sharing between domestic and foreign agents. Secondly, contrary to the regulators/policymakers’ intention and empirical evidence, the liquidity proxies document mixed evidence. Lastly, this study finds mixed evidence in the price volatility measures. However, the volatility and liquidity finding suggests that the presence of foreign institutional investors is not the source of excess volatility or high turnover on local bourses. Overall, the evidence, on average, shows some signs of improvement for different market efficiency measures during the post-liberalization period compared to the pre-liberalization period. The less than expected improvement in Tadawul during the post-period implies that the Saudi financial regulator’s incentive of opening the TASI for QFIIs coincides with economic vulnerabilities for the Kingdom, stringent QFIIs regulation and weak investor protection laws.

KEYWORDS:

• Qualified Foreign Institutional Investors (QFIIs)
• Security valuation
• Tadawul Stock Exchange (TASI)
• Financial regulation
• Liquidity
• Volatility

JEL CLASSIFICATION:

• G12
• G15
• G18

Disclosure statement

No potential conflict of interest was reported by the author.

ORCID

Saqib Sharif http://orcid.org/0000-0002-0005-7192

Notes

1 However, it is pertinent to mention that the opening of Saudi bourse to international investors has been a multistep process: Gulf Cooperation Council (GCC) countries nationals were allowed to invest in 2007 and non-Saudis through swap arrangements were allowed to trade / invest in 2008. Hence the results may be interpreted with little caution. Moreover, we have looked at the US Department of the Treasury’s website that shows the monthly average net buying by US citizens in Saudi bourse during pre-period is $187.17 compared to US$372.67 during post period, which is quite substantial. Hence this event can be considered as further relaxation to foreign institutional investors.

2 Recently, the Capital Market Authority (CMA), the market regulator of Saudi Arabia, has announced to open doors for short sellers to lure investors. See https://www.ft.com/content/df4fb6b4-1135-11e6-839f-2922947098f0

3 To adjust for autocorrelations of the residuals and fixed effects, the study re-estimated Equation (1) using OLS regression adjusting the t-values by Rogers standard errors clustered at the stock level. However, the results are qualitatively same, except slight change in the magnitude of coefficients.

4 During the 3-year pre-period, the daily average oil price was US$88 per barrel and post-period average was US$50 per barrel. The lower energy prices adversely affected export earnings of Saudi Arabia and corporate profits.

5 We also regressed daily trading volume on explanatory variables. However, the results are qualitatively similar.