The literature widely documents the negative liquidity impact of foreign participation in firms that permit high foreign institutional ownership. This paper employs a unique setting for the limited participation of qualified foreign institutional investors (QFII) in China’s A-share market and examines how this impacts on stock liquidity in emerging markets. Contrary to the findings in the literature, foreign investor participation helps enhance the liquidity of affected stocks by promoting trade activities and price discovery. The improvement in liquidity does not occur through the information friction channel, but rather the real friction channel. Our results are robust to endogeneity issue and the possible influence of the global financial crisis, industry effects and the stock exchange. Further, the liquidity improving effects of QFII are even stronger when the analysis is performed on a subsample of QFII firms.
Available for download on Saturday, January 12, 2019