The impact of foreign institutional traders on price efficiency: Evidence from the Taiwan futures market

• We study the relation between market efficiency and foreign institutional trading.
• Increasing foreign institutional trading brings negative impact on price efficiency.
• Foreign institutional traders play passive roles by submitting more limit orders.
• Foreign institutions are trading winners and domestic traders are trading losers.

The literature often suggests that foreign institutional traders in emerging markets play a positive role in the information production process. Using a unique dataset from the Taiwan Futures Exchange (TAIFEX), we directly investigate the association between market price efficiency and foreign institutional trading. We find that despite a significant increase in foreign institution trading on the overall market, the informational efficiency of the market price actually deteriorates. We reconcile this surprising finding by showing that foreign institutional traders are more likely to act as market makers on the TAIFEX by submitting passive limit orders.