Information asymmetry in emerging stock markets and behavioral implications

This work investigates barriers to information flow. Specifically, to what extent do geographic borders create information asymmetries between participants in emerging stock markets? If asymmetries exist, what are the behavioral consequences? Chapter 1 identifies three categories of equity analysts: locals (analysts located and headquartered in the target economy), foreigns (analysts located outside of the economy), and expatriates (analysts located in the economy but headquartered elsewhere). This innovative method of classification coupled with the application of new, hand-collected data from Taiwan allows location to be distinctly separated from resource imbalance as a potential cause of information asymmetry. Results show expatriates to be significantly better informed than their foreign counterparts; expatriate recommendations are a significant predictor of future stock returns, and trading on those recommendations yields positive excess returns. This implies that location is important in information acquisition. Puzzlingly, expatriates also outperform locals, indicating the importance of global resources. Chapter 2 addresses the equilibrium implications of this information asymmetry. Specifically, it addresses the question: how do parties with such widely varying abilities co-exist in a market? This study shows that uninformed parties essentially disregard their own information, opting instead to acquire and follow the recommendations of the informed. Testing foreign order flows as well as local and expatriate mutual fund flows, the study finds that local and foreign information are irrelevant to investing decisions: local and foreign institutions trade according to expatriate information, even when that information is contradictory to their own. This following behavior potentially creates a de-stabilizing positive feedback mechanism. Finally, Chapter 3 examines potential ethical and legal hazards created by the existence of a single informed party. Since expatriates are best-informed and know that others trade on their information, expatriates have incentive to trade prior to the release of that information, a practice that is unethical, expressly forbidden in Exchange Regulations, yet seldom prosecuted. By matching recommendations with prior trading both in aggregate and on a firm-by-firm basis, this study establishes with significance that expatriate traders do in fact trade in the same direction as their recommendations, buying (selling) before a positive (negative) recommendation or revision.