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Using the degree of accessibility of foreign investors to emerging stock markets, or investibility, as a proxy for the extent of foreign investments, we assess whether investibility has a significant influence on the diffusion of global market information across stocks in emerging markets. We show that greater investibility reduces price delay to global market information. We also find that returns of highly investible stocks lead those of noninvestible stocks because they incorporate global information more quickly. These results are consistent with the idea that financial liberalization in the form of greater investibility yields informationally more efficient stock prices in emerging markets.

Market integration is central to the international finance literature. Economists have long studied its welfare gains in terms of risk-sharing benefits (Karolyi and Stulz, 2003) and, more recently, have focused on investment and growth benefits associated with financial market integration (Bekaert et al., 2001, Bekaert et al., 2005 and Bekaert et al., 2009). Since the opening of many emerging markets to foreign equity investors in the late 1980s and early 1990s, there has been debate about the role of foreign portfolio capital in emerging markets. On the one hand, episodes of financial crises have prompted many to question the benefits of the liberalization process. On the other hand, a growing body of empirical evidence suggests that opening a market to foreign investors is beneficial. This evidence indicates that stock market liberalizations lower the cost of capital (Henry, 2000b and Bekaert and Harvey, 2000), increase real investment (Henry, 2000a, Mitton, 2006, Chari and Henry, 2008 and Bae and Goyal, 2010), and spur productivity and growth (Bekaert et al., 2005 and Bekaert et al., 2009). In this paper, we propose another benefit of stock market liberalizations: improved informational efficiency of prices in local stock markets. We posit that foreign investors are likely to have an advantage in processing global information and, therefore, contribute to the incorporation of such information into stock prices. An important feature of emerging markets is that not all stocks are accessible to foreign investors and the level of limits on foreign ownership varies widely across different stocks. We exploit this variation in foreign equity ownership restrictions across different stocks to study the impact of liberalization on the speed of information diffusion. Specifically, by examining the relation between a stock's accessibility to foreigners, or its investibility, and its stock return dynamics, we show that foreign investors facilitate faster diffusion of global market information among investible stocks in emerging markets. Our motivation for this study comes from a number of theoretical models that consider how the frictions in investors’ information environment affect market prices. Albuquerque, Bauer, and Schneider (2009), for example, consider a model in which global investors have global private information that is valuable for trading in many countries at the same time. The key assumptions in their model are that stock returns are driven by both local and global factors and that global investors receive signals regarding the global factors about which local investors know less. In this setting, they show that the information asymmetry between local and foreign investors with respect to global private information can lead local investors to underreact to movements in global factors. Because local investors underreact to global news, stocks that global investors cannot trade are not likely to incorporate global information promptly into their prices. Similarly, models employed by Merton (1987), Basak and Cuoco (1998), Shapiro (2002), and Hou and Moskowitz (2005) suggest a link between the speed of information diffusion and limited stock market participation. These models argue that institutional forces, information costs, or transactions costs can delay the process of information incorporation for firms with severe market frictions. We argue that market frictions such as restrictions on foreign equity investments in emerging markets are likely to impede swift processing of global market information, and we test the hypothesis that the removal of these restrictions improves the informational efficiency of stock prices in emerging markets. We obtain our data on firm characteristics and returns from the Standard & Poor's (S&P) Emerging Markets Database (EMDB). Our final sample includes weekly returns from 21 emerging markets for a total of 4,840 distinct stocks over the period from 1989 to 2008. The key variable for our analysis is a variable called the degree open factor, a measure constructed by the EMDB to measure the extent to which a stock is accessible to foreigners. The degree open factor allows us to proxy for the degree of foreign investibility. Using this measure, we classify stocks into three investibility groups: noninvestible (foreigners may not own any share of the stock), partially investible (foreigners may own up to 50% of the stock), and highly investible (foreigners may own more than 50% of the stock). Our main hypothesis is that the diffusion of global market information is faster for investible stocks than it is for noninvestible stocks. We refer to this hypothesis as the investibility-effect hypothesis. We design our experiment to test this hypothesis against the null of no-investibility-effect hypothesis in two ways. First, we test whether price delay to global market information is related to the degree of a stock's investibility. We measure price delay to global market information as the proportion of stock returns explained by the lagged world market returns in the regression of stock returns on contemporaneous and lagged world market and local market returns (Hou and Moskowitz, 2005). Intuitively, a larger value of this delay measure means that greater return variation is explained by lagged world market returns and, thus, is indicative of a sluggish response to global market information. To the extent that foreign equity investment restrictions bind and hamper the incorporation of value-relevant global information into the pricing of emerging market stocks, we should observe a negative relation between price delay measures and the degree of investibility in support of our investibility-effect hypothesis. Second, we examine whether a lead-lag pattern exists in the return dynamics between investible and noninvestible stocks. If investible stocks are faster at incorporating global information, which then slowly diffuses to noninvestible stocks, we should expect the returns on investible stocks to lead those on noninvestible stocks. Therefore, a lead-lag pattern between investible and noninvestible stock returns would be evidence in favor of the investibility-effect hypothesis. A difficulty we face in testing the investibility-effect hypothesis is that investibility could be correlated with other firm characteristics that might also affect the speed of information diffusion. To alleviate the concern that firm fundamentals could be correlated with investibility, we examine a subset of sample firms for which we can identify two types of ordinary shares issued: A shares and B shares. The distinction between these shares is that A shares can be traded only by domestic traders, whereas B shares are traded by foreign investors. Because the fundamentals of these two share classes are exactly the same, any difference in the speed of adjustment to global market information between A shares and B shares can be attributed only to the difference in their investibility, and any such evidence would be taken as evidence to refute the no-investibility-effect hypothesis. The empirical evidence supports the investibility-effect hypothesis. First, we show that the price delay to global market information is negatively associated with a stock's degree of investibility. In contrast, we find no relation between price delay to local market information and investibility. The absence of such a relation suggests that the degree of investibility is important only for the processing of global market information for which global investors can be especially instrumental. These findings are robust to the choice of different proxies for market information as well as to a variety of alternative regression specifications and control variables. Second, we find that the returns on highly investible stocks lead returns on noninvestible stocks, but not vice versa. Furthermore, we show that the component of highly investible stock returns related to global market information predicts the returns on noninvestible stocks. However, we find no evidence that returns on partially investible stocks lead those on highly investible stocks, even though the former are larger and more actively traded. These results are consistent with the investibility-effect hypothesis. Third, we find that B shares incorporate global market information into prices faster than A shares. In contrast, we find no difference between A and B shares in terms of their respective speed of adjustment to local market information. Furthermore, when we examine the return dynamics across A and B shares, we find that returns on a portfolio of B shares predict those on a portfolio of A shares. These results lend further support to the investibility-effect hypothesis. To the extent that the speed of price adjustment measures the degree of informational efficiency of stock prices in a market, our evidence indicates that removing capital barriers in the form of greater investibility in emerging markets can help improve informational efficiency of these stock markets. Our paper is closely related to several studies that use the investibility measure to investigate the effects of stock market liberalizations. In a pioneering paper that makes use of the investibility measure as a proxy for foreign equity ownership restrictions, Bekaert (1995) examines the relation between the degree of market integration and investment barriers in emerging markets. He measures the extent of market openness at the country level, using the ratio of market value of investible stocks to total market capitalization. Edison and Warnock (2003) and De Jong and De Roon (2005) use the same measure in their studies of capital controls on emerging stock markets. Boyer, Kumagai, and Yuan (2006) show a greater degree of co-movement between investible stock index returns and crisis country index returns during crisis periods. While these authors measure the intensity of capital controls at the country level, several other studies use an investibility measure at the individual firm level. For instance, Bae, Chan, and Ng (2004) find a positive relation between return volatility and investibility. Chari and Henry (2004) show that investible stocks realize higher risk-sharing benefits when countries liberalize their stock markets. Mitton (2006) studies how the degree of investibility affects firm performance and shows that investible firms experience increases in sales growth, profitability, and efficiency and decreases in their leverage. Our paper also contributes to a large literature that investigates the information asymmetry between local and foreign investors. Whether foreigners are more or less informed relative to locals is an important and controversial issue in international finance literature.1 Several studies attempt to identify whether foreign investors have an informational disadvantage. The results are at best mixed. Some studies show that local traders perform better than foreign traders (Hau, 2001, Choe et al., 2005 and Dvorak, 2005). Similarly, using analysts' earnings forecast data, Bae, Stulz, and Tan (2008) show that local analysts forecast earnings more accurately than foreign analysts. However, numerous studies also suggest that foreign investors are better informed (Grinblatt and Keloharju, 2000, Seasholes, 2000 and Froot et al., 2001). Our results add to the understanding of this issue by showing that foreign investors could have an advantage in processing global market information. While foreign investors could be at an informational disadvantage to domestic investors in obtaining local information, they are likely to have better resources and expertise in processing global information. Depending on the relative importance of domestic and global information reflected in stock prices, one could find that foreign investors are better informed or less informed, which could offer an explanation for the mixed evidence so far on the performance of foreign investors relative to domestic investors. Finally, our paper is related to a long-standing literature on predictability in asset prices. Since the seminal work of Lo and MacKinlay (1990), which shows that returns of large stocks predict returns of small stocks, but not vice versa, cross-autocorrelation patterns among stock returns have received much attention in the literature. Factors that are identified as contributing to the cross-autocorrelations in stock returns include the number of analysts following (Brennan, Jegadeesh, and Swaminathan, 1993), institutional ownership (Badrinath, Kale, and Noe, 1995), and trading volume (Chordia and Swaminathan, 2000). While debate is ongoing about what the sources of these predictability patterns are, these studies point to the presence of market frictions in generating differences in the speed of adjustment across stocks. By showing that market frictions in the form of equity ownership restrictions impede information diffusion, our study provides additional support to the slow information diffusion hypothesis as the leading cause of lead-lag relation in returns. The rest of the paper is organized as follows. In the next section, we present descriptive statistics of the data. Section 3 examines the impact of investibility on the speed of price adjustment, and Section 4 examines the lead-lag relation between stocks with different degrees of investibility. Section 5 examines the subset of sample firms for which both A and B shares are available. Section 6 concludes.

In this paper, we propose another benefit of stock market liberalization by investigating how greater investibility impacts the informational efficiency of emerging stock markets. We argue that foreign investors can help facilitate the diffusion of global market information into stock prices. We examine the relation between a stock's accessibility for foreigners and its stock return dynamics, and we show that greater investibility is associated with faster diffusion of global market information into stock prices. Our findings can be summarized as follows. First, we find that greater investibility improves the speed of price adjustment to global market information. The participation of foreign investors appears to be instrumental especially for the transmission of information that is global in nature. We find that the relation between investibility and global delay is more negative than that between investibility and local delay. Second, returns on highly investible stocks lead those on noninvestible stocks, but not vice versa. This lead-lag relation is independent of factors such as size or volume, and it is due to investible stocks incorporating global information more quickly than noninvestible stocks. Finally, when we exploit the incidence of A and B shares in our sample, we find that B shares that foreign investors trade react faster to global information than A shares that local investors trade. We also find that the returns of B shares can predict those of A shares, but not vice versa. Overall, our findings are consistent with the idea that financial liberalization in the form of greater investibility yields informationally more efficient stock prices in emerging markets.