Divergent Expectations and the Asian Financial Crisis of 1997

An important question concerning integration of global financial markets is whether local investors in an equity market react differently from international investors, particularly during periods of financial crisis. Considering local investors are closer to information, they might turn pessimistic before foreign investors prior to a crisis. We examine whether local investors in each of the six Asian stock markets, including Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand, reacted differently from international investors during the 1997 Asian financial crisis. Our empirical results indicate that, in general, closed-end country fund share prices (mainly driven by foreign investors) Granger-cause the respective net asset values (NAVs, mainly driven by local investors). Moreover, this one-way Granger causality effect from share prices to NAVs becomes much stronger during the crisis period after controlling for U.S. stock returns. Our results suggest that international investors turned pessimistic before local investors