Knut Wicksell Working Paper Series,
Lund University, Knut Wicksell Centre for Financial Studies

Abstract: The Chinese government has implemented the Qualified Foreign Institutional Investor (QFII) system in order to promote stock market liquidity by participation of foreign institutional investors. This paper is the first to explicitly identify the channels through which foreign institutional investors influence the liquidity on the Chinese stock markets. Firstly, we find that market participation by foreign institutional investors promotes liquidity both for state-owned enterprises (SOEs) and non-SOEs. Secondly, foreign institutions influence liquidity through the informational frictions channel, but not through the real frictions channel. Thirdly, as implied by these two results, foreign institutions are not informationally disadvantaged when investing in SOEs. Finally, the link between foreign institutional participation and liquidity remains strong before, during, and after the recent financial crisis.

Keywords: Liquidity; emerging markets; foreign institutional investors; real frictions; informational frictions

JEL-codes: C23; G12; G18; G32

36 pages, June 19, 2013

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