Foreign Investment Fluctuations and Emerging Market Stock Returns: The Case of Mexico

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Foreign Investment Fluctuations and Emerging Market Stock Returns: The Case of Mexico

May 1997 Number 24

JEL classification: F12, G12, G15

Authors: John Clark and Elizabeth Berko

We investigate the economically and statistically significant positive correlation between monthly foreign purchases of Mexican stocks and Mexican stock returns. We find that a 1 percent of market capitalization surprise foreign inflow is associated with a 13 percent increase in Mexican stock prices. We explore whether this correlation might be explained by permanent reductions in conditional expected returns resulting from expansion of the investor base along the lines modeled by Merton (1987), or correlations with other factors causing returns, price pressures, or positive feedback strategies by foreign investors, and conclude that the available evidence is consistent with the base-broadening hypothesis.

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