Hot money and cross-section of stock returns during the global financial crisis

- We examine the impact of hot money in the South Korean stock market.
- Capital flow preceding the global financial crisis has characteristic of hot money.
- More pre-crisis capital flow led to bigger price drop during the crisis.
- Our analysis is based on cross-sectional analysis.
- Our findings extends the evidence of the destabilizing effect of hot money.

We investigate a hitherto unexplored aspect of the hot money phenomenon: the effect of hot money at the individual stock level. In the South Korean stock market, foreign capital flow right before the global financial crisis can be characterized as hot money. A larger increase in foreign investors' ownership of a particular stock in the pre-crisis period resulted in a bigger decline in their ownership of the stock, a sharper drop in the stock's price, and higher volatility of the stock during the crisis. Our findings supplement the existing evidence for the destabilizing effect of certain international capital flows.