How Do Foreigners Profit from Local Investors? Evidence from Trades in the Japanese Stock Market

Using data on trading across the entire Tokyo Stock Exchange, we examine the trade interactions of various investor types. Since buy trades must be cleared by the sell trades of other investors, we relate the trade interactions of various investor groups to the relative trading cost and timing among different investor groups. The interaction between foreign investors and domestic financial institutions represents one of the most important patterns of interactions during the 1990s. We find that foreign investors tend to profit from domestic institutional investors. In particular, domestic institutions sell shares to realize capital gains on their portfolio holdings near the fiscal year-end. Because of this practice, domestic institutions' investment timing is hampered and the cost of trading increases. Foreigners exploit this opportunity since they need not follow the Japanese corporate accounting rules