Asymmetric Information or Asymmetric Reputation? A Theory on Why Foreigners Earn So Much in a Small Open Emerging Market

Abstract

In this paper, we theoretically examine whether, and why, more informed traders (for example, foreigners) in an emerging market earn more than their informational advantage would justify. Anecdotal evidence suggests that once foreign traders establish themselves in the market, they outperform other informed traders, such as local institutions, even in the absence of any informational advantage. Noise traders, like local individuals, always lose the most. Also, ironically, an extraneous shock to foreigners could also work in favor of them and against locals as long as foreigners keep a good reputation. One possible reason explored in this paper is that the strong performance of foreign traders in local markets might be more attributable to locals' trust in them than to their informational advantage.