This study shows the following results, by analyzing the determinants of
foreign investors’ domestic bond investment and their impacts on the Korean
bond market. First of all, foreigners’ bond investment depends on arbitrage
trading opportunities and country risks. The foreign bond investment has
jumped in a large scale after the 2nd half of 2007. This is mainly due to the
expansion of arbitrage trading opportunities and higher sensitivity to those
opportunities. The increase of foreign investment was also led by the
government’s capital control. Furthermore, foreigners have influenced the
Korean domestic bond market since the 2nd half of 2007 in quite different
ways. Our study suggests that in the course of capital liberalization, the
government’s direct capital control may have little or even adverse effects,
depending on foreigners’ responses. The government should consider the
foreign investors’ behaviors carefully when executing financial and exchange
rate policies.