Foreign investors and stock return anomalies

Abstract

This paper investigates whether foreign investors exploit market anomalies in the Korean stock market from 1998 to 2020. Our anomaly set contains price momentum, EBITDA-to-price, gross profit-to-asset, free cash flow-to-price, cash-based operating profit-to-price, sales growth, share turnover, and mispricing score. We measure the mispricing score as the average rank of anomalies each month. Foreign investors tend to imitate the market portfolio, but at the same time, they deviate their portfolio efficiently from the market with a significant Fama-French five-factor alpha of 0.42% per month. Foreign investors generate this alpha by underweighting overpriced stocks, and this pattern is consistent whether fund liquidity is high or low. Regarding the residual analyst coverage as the proxy of information asymmetry, foreign investors invest less in stocks with high information asymmetry, which means they are reluctant to correct mispricing in stocks with less information.