Institutional ownership and liquidity commonality: evidence from Australia

TL;DR

This paper investigates how foreign and local institutional ownership influence liquidity commonality in the Australian stock market, revealing that foreign ownership increases liquidity commonality especially in large and mid-cap stocks, with implications for market stability.

Contribution

It provides new evidence on the differential impact of foreign versus local institutional ownership on liquidity commonality in Australia, highlighting the role of foreign investors in market dynamics.

Findings

Foreign institutional ownership increases liquidity commonality in large and mid-cap stocks.

Liquidity commonality has grown over two decades, especially due to foreign ownership.

Correlated trading by foreign institutions explains the increased commonality.

Abstract

We study the liquidity commonality impact of local and foreign institutional investment in the Australian equity market in the cross-section and over time. We find that commonality in liquidity is higher for large stocks compared to small stocks in the cross-section of stocks, and the spread between the two has increased over the past two decades. We show that this divergence can be explained by foreign institutional ownership. This finding suggests that foreign institutional investment contributes to an increase in the exposure of large stocks to unexpected liquidity events in the local market. We find a positive association between foreign institutional ownership and commonality in liquidity across all stocks, particularly in large and mid-cap stocks. Correlated trading by foreign institutions explains this association. However, local institutional ownership is positively related to the commonality in liquidity for large-cap stocks only.