The impact of foreign trades on emerging market liquidity

• We examine how foreign trades affect liquidity commonality in an emerging market.
• We find that foreign trades have both negative and positive effects.
• Aggressive foreign trades contribute significantly to price discovery.
• Foreign trades also have an adverse impact on domestic liquidity commonality.
• Overall, our study shows that foreign investor trading is a double-edged sword.

We examine the transmission mechanisms through which foreign trades affect commonality in liquidity in an emerging stock market. Trade-level data from the Indonesian Stock Exchange allow us to examine the impact of aggressive foreign trades on commonality in liquidity. Our results show that these trades contribute significantly to the price discovery process as well as to increasing commonality in liquidity. We find that the price discovery impact of aggressive foreign trading provides the mechanism through which foreign investor trading affects emerging market liquidity dynamics. Overall, our study shows that foreign investor trading is a double-edged sword.