Florida State researchers: Foreign investments may be destabilizing financial markets

Bong-Soo Lee

Stabilizing or destabilizing? Good or bad? Many have debated the positives and negatives of sovereign wealth fund investments–pools of money that foreign governments, China in particular, have invested for profit in a number of U.S. investment banks. None, however, have shed light on the fundamental question: Do such investments help or hurt?

Until now.

Researchers at the Florida State University College of Business have found evidence that suggests such foreign investments are destabilizing to financial markets, confirming media speculation that sovereign wealth funds could do more damage than good.

"Our research, which is based on recent empirical techniques to establish statistical relationships, finds that risk and return decrease after sovereign wealth fund investment," said Bong-Soo Lee, the Patty Hill Smith Eminent Scholar Chair in Finance at Florida State and lead author of the research findings. "Furthermore, we find that risk is not sufficiently reduced to offset the change in return, at both the firm and market levels, which suggests that the sovereign wealth fund investment is destabilizing."

"’Sleeping with the Enemy’ or ‘An Ounce of Prevention’: Sovereign Wealth Fund Investments and Market Destabilization," the paper authored by Lee, finance Assistant Professor April Knill and a graduate student in the College of Business, will be presented at the Darden International Finance Conference in Charlottesville, Va., in March.

As the current economic crisis continues to rage throughout the world, market destabilization related to sovereign wealth funds continues to be discussed:

  • President Barack Obama, during his presidential campaign, expressed concern that sovereign wealth funds are motivated "by more than just market considerations." (Reuters.com, Feb. 7, 2008)
  • A study done by the Government Accountability Office found that six out of 10 countries surveyed expressed discomfort with sovereign wealth funds.
  • The U.S. Senate’s Security and International Trade and Finance Committee, led by Sen. Evan Bayh, D-Ind., will convene to debate sovereign wealth funds’ potential for destabilization/national security risks. (Link)

Although the news media have covered the issue of sovereign wealth funds extensively, the researchers found no connection between the destabilization of the investments and the coverage.

"After reviewing all articles written about sovereign wealth fund investments, in both academic and popular press, we gathered a data set of sovereign wealth fund transactions," Lee said. "We analyzed these transactions for performance of the firms and markets involved. We found no evidence to suggest that media coverage caused any of the destabilization seen with these sovereign wealth fund investments."