Political conflict and foreign portfolio investment: Evidence from North Korean attacks

• We examine the response of foreign investors to escalating political conflict.
• We study the impact on the South Korean market of 13 North Korean military attacks.
• Following attacks, foreigners increase holdings and maintain pre-attack performance.
• Domestic institutions improve performance and domestic individuals perform worse.
• Results are consistent with the predicted benefits of international diversification.

We examine the response of foreign investors to escalating political conflict and its impact on the South Korean stock market surrounding 13 North Korean military attacks between 1999 and 2010. Using domestic institutions and domestic individuals as benchmarks, we evaluate the trading behavior and performance of foreign investors. Following attacks, foreigners increase their holdings of Korean stocks and buy more shares of risky stocks. Performance results show foreigners maintain their pre-attack level of performance while domestic individuals, who make the overwhelming majority of domestic trades, perform worse. In addition, domestic institutions improve their performance. Overall, the results are consistent with the predictions based on the benefits of international diversification. Unlike domestic individuals, foreigners trade more shares than usual and deviate from their general strategy of positive feedback trading.