Offshore Investment Funds: Monsters in Emerging Markets?

Abstract

This working paper was written by Woochan Kim (Korea Development Institute) and Shang-Jin Wei (Harvard University).The 1997-99 financial crises in the emerging markets have brought to the foreground the concern about offshore investment funds and their possible role in exacerbating financial market volatility. Offshore investment funds are alleged to engage in trading behaviors that are different from their onshore counterparts. Because they are less moderated by tax consequences, and are subject to less supervision and regulation, the offshore funds may trade more intensely. They could also engage more aggressively in certain trading patterns such as positive feedback trading or herding that could contribute to greater market volatility. Using a unique data set, we compare the trading behavior of offshore funds in Korea with that of three sets of onshore funds as control groups. There are a number of interesting findings. First, the offshore funds do trade more intensely than their onshore counterparts. Second, however, the offshore funds do not engage in positive feedback trading in a significant way. In contrast, there is strong evidence that the onshore funds from the U.S. and U.K. do engage in positive feedback trading. Third, while offshore funds herd, they did so significantly less than the onshore funds during the crisis. In sum, the offshore funds are not especially worrisome monsters.