Over-reaction in Foreigners' Expectations

Zhiyu Fu, Joint Program in Financial Economics PhD student

In my ongoing project, I show that foreign flows are more sensitive to financial situation in recipient countries than domestic flows.1 During financial distress, foreigners withdraw more capital from the
destination countries than domestic investors. This pattern cannot be explained by currency risks, regulations, or different risk exposures. Furthermore, higher sensitivity costs foreigners: following foreigners’ trading strategy, they receive lower alpha and Sharpe ratio. These results suggest that foreigners over-react to the economic and financial news. In this project, I plan to use cross-country economic forecast data to directly test this hypothesis. Consensus Economics provides individual-level forecasts for each country. Using this dataset, I can test whether foreign forecasters are indeed more sensitive to economic news than domestic forecasters.