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This paper investigates the question of whether the stability of financial markets is damaged by foreigner’s stock investment by estimating its dynamic relationships with stock price and exchange rate in East Asia, focusing on the 2007-2009 global financial crisis. We find that the negative effects of foreigner’s stock investment on stock price and exchange rate are much stronger during a crisis than in normal times in many East Asian countries. This finding suggests that foreigner’s stock investment could act as a destabilizing factor in domestic financial markets, especially in the face of global financial disturbances. In particular, the Korean exchange market is found to be most vulnerable to the global shocks among East Asian countries. As the impact of the global common shocks turns out to be very substantial in East Asian countries, policy makers should strengthen financial cooperation within this region. Increasing the intra-regional trades in stocks is expected to promote the financial stability in this region by providing opportunities for sharing investment risks among East Asian countries. In addition, regulatory measure such as the Tobin tax may be useful in limiting capital movements against a possible crisis.
