market segmentation and price differentials of dual-listed shares:...
TRANSCRIPT
Market segmentation and Price differentials
of dual-listed shares:
An empirical study on Chinese A-Shares and H-Shares
BY
Chau Man Tai Andy
05000084
Major in Finance
An Honours Degree Project Submitted to the School of Business
in Partial Fulfillment of the Graduation Requirement for the
Degree of Bachelor of Business Administration (Honours)
Hong Kong Baptist University
April 2008
Acknowledgement
First of all, I would like to thank my Honors Project Supervisor Dr. Billy Mak for his
insightful and generous advice on this project. His expertise in research area gives me
lots of ideas and suggestions which help my report to merit. Without his kind support,
this study could not be accomplished as a valuable piece.
I would like to express my thankfulness and appreciation for all the teaching staff in
the Finance Department who have given me valuable input to my studies and
countless opportunities to participate various kinds of activities in the University.
I would also like to express my sincere thank to my classmates, friends, family
members for their encouragement throughout the whole research process.
Content
ABSTRACT........................................................................................................................................- 1 -
1. INTRODUCTION....................................................................................................................- 2 -
2 LITERATURE REVIEW........................................................................................................- 4 -
2.1. PRICE PREMIUM OF FOREIGN SHARES............................................................................. - 4 -
2.2. PRICE DISCOUNT OF FOREIGN SHARES ............................................................................ - 4 -
2.2.1. Price discount of B-shares ..........................................................................................- 4 -
2.2.2. Price discount of H-shares..........................................................................................- 5 -
3. INSTITUTIONAL SETTING.................................................................................................- 6 -
4. CROSS-SECTIONAL ANALYSIS.........................................................................................- 9 -
4.1. HYPOTHESES .................................................................................................................... - 9 -
4.1.1. Information asymmetry between domestic and foreign investors............................- 10 -
4.1.2. Market capitalization ................................................................................................ - 11 -
4.1.3. Liquidity..................................................................................................................... - 11 -
4.1.4. Supply of shares ........................................................................................................- 12 -
4.1.5. Diversification benefit ...............................................................................................- 13 -
4.2. EQUATION OF MULTIPLE REGRESSION.......................................................................... - 13 -
5. DATA ......................................................................................................................................- 14 -
5.1. DESCRIPTIVE STATISTICS .............................................................................................. - 15 -
6. REGRESSION RESULT AND DISCUSSION.................................................................... - 17 -
7. CONCLUSION.......................................................................................................................- 22 -
REFERENCES.................................................................................................................................- 23 -
Abstract
This paper examines the relationship between market segmentation and price
differentials of dual-listed stocks in Chinese stock markets. By the end of March
2008, there are 53 China enterprises that have dual-listed in China (A-shares) and
Hong Kong (H-shares). Under Law of One Price, A-share prices should be the same
as H-share prices in an efficient market. However, A-share and H-share markets are
segmented, which leads to H-share prices are usually trading at a discount compared
to A-share prices. This paper demonstrates that company specific factors related to
information asymmetry, liquidity, market capitalization and demand of shares are
important factors to explain the price discount of H-shares.
- 1 -
1. Introduction
Due to the integration of financial industry, many companies not only can raise
capital in the domestic market, they also can raise capital by listing their shares in
foreign markets. Thus, these companies are dual-listed in domestic and foreign
markets. Under the theory of Law of One Price, the dual-listed shares should not have
price differential in an efficient market. It is because both shares belong to the same
company, so the investors have the same shareholders’ rights and they receive the
same future dividends. However, if the domestic and foreign markets are segmented,
the stock prices differential between these markets can be quite substantial (Eun and
Janakiramanan, 1986). Market segmentation generally can be explained by
information asymmetry between domestic and foreign investors, difference in
language, political and macroeconomic risk, clientele bias, liquidity and others.
Based on previous studies of dual-listed shares of developed capital markets
(America and Europe), market segmentation commonly results in price premium of
foreign shares relative to home shares (Bailey and Jagtiani, 1994; Stulz and
Wasserfallen, 1995; Domowitz, Glen and Madhavan, 1997). In contrast to the
mainstream researches, Bailey (1994) first discovers that the price of B-shares, which
are traded by foreign investors but in the same trading location as A-shares, are
- 2 -
trading at a discount compared to the price of domestic A-shares. Furthermore, Sun
and Tong (2000) and Mei, Scheinkman and Xiong (2005) show that both B-Shares
and H-Shares have significant price discounts relative to A-shares. By the end of
March 2008, nearly all H-shares’ prices are trading at a discount compared to
A-shares’ and the mean price discount is about 38% (Table 1).
Table 1: Distribution of daily average price discount
(April 2003—March 2008)
Daily average discounts SHSE (n=46) SZSE (n=7) Whole sample (n=53)
-20%<Discount≦0% 2 0 2
0%<Discount≦20% 5 2 7
20%<Discount≦40% 19 1 20
40%<Discount≦60% 15 1 16
60%<Discount≦80% 5 3 8
Mean Discount 38.01% 44.39% 38.85%
The structure of B-Shares and H-Shares are similar, but the trading locations of
the two classes of shares are different. The trading activities of B-Shares take place in
Shanghai and Shenzhen, which is the same as the A-Shares, while the trading
activities of H-shares are in Hong Kong. An interesting question is whether the price
discount of H-shares is caused by the same factors of the price discount of B-shares.
Bergstorm and Tang (2001) shows that the price discount of B-Shares can be
explained by information asymmetry between foreign investors and domestic
investors, liquidity effects, diversification effects, clientele bias, risk-free return
differentials between foreign and domestic investors, and foreign exchange risks. This
- 3 -
paper examines the hypotheses of the above factors (Bergstorm and Tang, 2001) and
check whether they can explain the price discount of H-shares.
2 Literature Review
2.1. Price premium of foreign shares
The problem of price premium of foreign shares under market segmentation has
been started analyzing since 1970. Hietala (1989) uses a modified CAPM model to
show an unrestricted stock is traded at a price premium relative to the corresponding
restricted stock if foreign investors require a lower rate of return on this stock than
domestic investors do. She also finds that the size of the premium is determined by
the international and domestic beta of the stock. Domowitz, Glen and Madhavan
(1997) find that the price premium for foreign shares is positively related to proxies
for foreign demand and is negatively related to the relative supply of foreign shares,
but the proxy for relative liquidity cannot explain the price premium.
2.2. Price discount of foreign shares
2.2.1. Price discount of B-shares
The first price discount of foreign shares is documented by Bailey (1994). He
finds the price discounts on B-shares relative to A-shares are inconsistent with
premiums observed in other Asian capital markets. Sun and Tong (2000) suggests that
- 4 -
foreign investors are important to the B-share price discount phenomenon. Foreign
investors demand for B-shares is quite elastic because Red Chip shares and H-shares
in Hong Kong stock market are good substitutes for B-shares. In addition, the
difference in expectations of firms’ growth rates between Chinese investors and
foreign investors also is a major factor to explain the price differential. He adds that
return volatility, bond supply, share supply and liquidity have explanatory powers to
this phenomenon. Poon, Firth and Fung (1998) find that the relative liquidity of
B-shares to A-Shares is negatively related to the price discount, and they comment
that the price discount is mainly due to the illiquidity of B-shares. Chakravarty, Sarkar
and Wu (1998) show that information asymmetry between local and foreign investors
is a crucial factor to explain the price discount of B-shares.
2.2.2. Price discount of H-shares
Wang and Jiang (2004) claim market segmentation is mainly induced by
ownership restriction and exchange control in mainland China. They document a large
time-varying H-share price discount relative to A-shares and this discount is highly
correlated with the domestic and foreign stock market indices and relative market
illiquidity. They also show that H-share price discount is positively correlated with the
expected devaluation in the Chinese currency. Y. Li et al. (2006) illustrate that the
- 5 -
H-shares price discount is mainly attributable to the deviation in the systemic risk
premiums of the local markets.
3. Institutional setting
The Shanghai Stock Exchange (SHSE) and Shenzhen Stock Exchange (SZSE)
were established on November 26, 1990 and April 11, 1991 respectively. The two
exchanges are independent and dual-listing between them is not permitted. However,
dual-listed is allowed under the same exchange in the form of B-shares. Stocks listed
in SHSE and SZSE can cross list in Hong Kong stock market in the form of H-shares.
Therefore, there are 3 classes of shares issued by China enterprises in the form of
A-shares, B-shares and H-shares. A-shares are domestic shares that are restricted to
domestic investors and traded with Chinese yuan; B-shares and H-shares are both
foreign shares that are restricted to foreign investors and traded with US dollars and
HK dollars respectively. In addition, Qualified Foreign Institutional Investor (QFII)
was launched in 2002, approved foreign investors were allowed to invest in A-share
market but with a limited quota of fund. Qualified Domestic Institutional Investor
(QDII) was launched in 2006, approved domestic investors were allowed to invest in
foreign market but with a limited quota of fund.
History of Hong Kong stock market dates back 100 years history ago. Now,
- 6 -
Hong Kong stock market is a mature, well established market with strict listing
requirements and information disclosure. Compare with Hong Kong stock market,
China stock market is still green and with poor information disclosure. The market is
dominated by retail investors and most policies are controlled by the government.
Table 2: The China stock market constitution
Hong Kong Shanghai Shenzhen
Main Board GEM A Share B Share A Share B Share
No. of listed companies 1,055 189 851 54 676 55
No. of listed H shares 107 40 n.a. n.a. n.a. n.a.
No. of listed red-chips stocks 88 5 n.a. n.a. n.a. n.a.
Total no. of listed securities 6,508 193 n.a. n.a. n.a. n.a.
Total market capitalization
(Bil. dollars) HKD 16,825 HKD 113 RMB 18,046 RMB 89 RMB 4,453 RMB 101
Total negotiable
capitalization (Bil. dollars) n.a. n.a. RMB 5,222 RMB 89 RMB 2,244 RMB 100
Average P/E ratio (Times) 13.68 17.18 39.45 41.85 39.34 16.82
From table 2, there are 147 H-shares listed in Hong Kong of which 53 stocks are
dually listed in China and Hong Kong. One important item is that the some shares in
China are not tradable/transferable. These shares are held by the government or legal
person and employee. As a result, the total negotiable capitalization (shown in the
table 2) is the market capitalization of tradable shares.
Table 3: Dual-listed stocks in A- and H-share Markets (53 companies)
- 7 -
H-share
code
A-share
code Name
H-share
listing date
A-share
listing date
00042 000585.SZ Northeast Electric Development Co. Ltd. 06/07/1995 13/12/1995
00168 600600.SS Tsingtao Brewery Co. Ltd. 15/07/1993 27/08/1993
00177 600377.SS Jiangsu Expressway Co. Ltd. 27/06/1997 16/01/2001
00187 600860.SS Beiren Printing Machinery Holdings Ltd. 06/08/1993 06/05/1994
00300 600806.SS Shenji Group Kunming Machine Tool Co. Ltd. 07/12/1993 03/01/1994
00317 600685.SS Guangzhou Shipyard International Co. Ltd. 06/08/1993 28/10/1993
00323 600808.SS Maanshan Iron & Steel Co. Ltd. 03/11/1993 06/01/1994
00338 600688.SS Sinopec Shanghai Petrochemical Co. Ltd. 26/07/1993 08/11/1993
00347 000898.SZ Angang Steel Co. Ltd. 24/07/1997 25/12/1997
00350 000666.SZ Jingwei Textile Machinery Co. Ltd. 02/02/1996 10/12/1996
00358 600362.SS Jiangxi Copper Co. Ltd. 12/06/1997 11/01/2002
00386 600028.SS China Petroleum & Chemical Corporation 19/10/2000 08/08/2001
00390 601390.SS China Railway Group Ltd. 07/12/2007 03/12/2007
00525 601333.SS Guangshen Railway Co. Ltd. 14/05/1996 22/12/2006
00548 600548.SS Shenzhen Expressway Co. Ltd. 12/03/1997 25/12/2001
00553 600775.SS Nanjing Panda Electronic Co. Ltd. 02/05/1996 18/11/1996
00588 601588.SS Beijing North Star Co. Ltd. 14/05/1997 16/10/2006
00670 600115.SS China Eastern Airlines Corporation Ltd. 05/02/1997 05/11/1997
00719 000756.SZ Shandong Xinhua Pharmaceutical Co. Ltd. 31/12/1996 06/08/1997
00753 601111.SS Air China Ltd. 15/12/2004 18/08/2006
00763 000063.SZ ZTE Corporation 09/12/2004 18/11/1997
00857 601857.SS PetroChina Co. Ltd. 07/04/2000 05/11/2007
00874 600332.SS Guangzhou Pharmaceutical Co. Ltd. 30/10/1997 06/02/2001
00902 600011.SS Huaneng Power International, Inc. 21/01/1998 06/12/2001
00914 600585.SS Anhui Conch Cement Co. Ltd. 21/10/1997 07/02/2002
00921 000921.SZ Hisense Kelon Electrical Holdings Co. Ltd. 23/07/1996 13/07/1999
00939 601939.SS China Construction Bank Corporation 27/10/2005 25/09/2007
00991 601991.SS Datang International Power Generation Co., Ltd. 21/03/1997 20/12/2006
00995 600012.SS Anhui Expressway Co. Ltd. 13/11/1996 07/01/2003
00998 601998.SS China CITIC Bank Corporation Ltd. 27/04/2007 27/04/2007
01033 600871.SS Sinopec Yizheng Chemical Fibre Co. Ltd. 29/03/1994 11/04/1995
01053 601005.SS Chongqing Iron & Steel Co. Ltd. 17/10/1997 28/02/2007
01055 600029.SS China Southern Airlines Co. Ltd. 31/07/1997 25/07/2003
01065 600874.SS Tianjin Capital Environmental Protection Co. Ltd. 17/05/1994 30/06/1995
01071 600027.SS Huadian Power International Corporation Ltd. 30/06/1999 03/02/2005
01072 600875.SS Dongfang Electric Corporation Ltd. 06/06/1994 10/10/1995
01088 601088.SS China Shenhua Energy Co. Ltd. 15/06/2005 09/10/2007
01108 600876.SS Luoyang Glass Co. Ltd. 08/07/1994 31/10/1995
01138 600026.SS China Shipping Development Co. Ltd. 11/11/1994 23/05/2002
01171 600188.SS Yanzhou Coal Mining Co. Ltd. 01/04/1998 01/07/1998
01186 601186.SS China Railway Construction Corporation Ltd. 13/03/2008 10/03/2008
01398 601398.SS Industrial and Commercial Bank of China Ltd. 27/10/2006 27/10/2006
- 8 -
01898 601898.SS China Coal Energy Co. Ltd. 19/12/2006 01/02/2008
01919 601919.SS China COSCO Holdings Co. Ltd. 30/06/2005 26/06/2007
02318 601318.SS Ping An Insurance (Group) Co. of China Ltd. 24/06/2004 01/03/2007
02338 000338.SZ Weichai Power Co. Ltd. 11/03/2004 30/04/2007
02600 601600.SS Aluminum Corporation of China Ltd. 12/12/2001 30/04/2007
02628 601628.SS China Life Insurance Co. Ltd. 18/12/2003 09/01/2007
02866 601866.SS China Shipping Container Lines Co. Ltd. 16/06/2004 12/12/2007
02883 601808.SS China Oilfield Services Ltd. 20/11/2002 28/09/2007
03328 601328.SS Bank of Communications Co., Ltd. 23/06/2005 15/05/2007
03968 600036.SS China Merchants Bank Co., Ltd. 22/09/2006 09/04/2002
03988 601988.SS Bank of China Ltd. 01/06/2006 05/07/2006
4. Cross-sectional analysis
Cross-sectional model is used because it can give an overall behavior of
dual-listed A- and H-Shares at once. The model investigates whether the company
specific factors related to information asymmetry, diversification, liquidity, market
capitalization and demand of shares can explain the price discount of H-Shares. The
dependent variable is the average daily price discount for individual companies, i.e.
DISit = (PA,it – PH,it Xt)/ PA,it
where PA,it and PH,it are firm i’s A- and H-share’s closing price at time t, and Xt is the
exchange rate between Chinese RMB and the Hong Kong dollar.
4.1. Hypotheses
The following independent variables are potential causes of H-share price
discount:
- 9 -
4.1.1. Information asymmetry between domestic and foreign investors
Chakravarty, Sarkar and Wu (1998) shows that the price discount on B-shares is
1.) negatively related to the covariance of returns of A- and B-shares divided by the
variance of price of A-share; 2.) positively related to the variance of B-share returns.
As B- and H-share are similar in nature, it is possible that H-shares will exhibit the
same features as B-shares. For that reason, the above arguments are set to be the
hypotheses for testing the model of H-share price discount:
1. negatively related to SHAit = [Cov(rA,it, rH,it) / Var(PA,it)] ;
2. positively related to VARHit = Var(rH,it)
where rA,it and rH,it are the return of firm i’s A- and H-shares at time t.
Intuitively, SHAit measures the return sensitivity of H shares to the A shares. A
high value of Cov(rA,it, rH,it) implies that A share returns are informative about H share
returns, and foreign investors can more easily infer the H-share price from the A-share
price even information is not accessible by foreign investors.. A high value of
Var(PA,it) means that the price of A shares is very noisy, which leads foreign investors
difficult to learn the future return precisely. Therefore, SHAit should be negatively
related to the H-share discount. VARHit measures the volatility of H-share. A high
value of Var(rH,it) makes foreign investors difficult to make prediction on the future
- 10 -
return. So, SHAit should be positively related to the H-share discount.
4.1.2. Market capitalization
Market capitalization (SIZEit) is another proxy to determine the information
asymmetry. Companies with high market capitalization are usually analyzed by
foreign institutional investors and these companies also have good media coverage.
Thus, the information of large-cap companies can be obtained easily. However,
small-cap companies are relatively less transparent as media and foreign institutional
investors have less interest on them. Therefore, SIZEit should be negatively related to
the H-share discount.
4.1.3. Liquidity
Liquidity measures the degree of readiness to which the shares can be bought or
sold in the market without affecting the price. Two common liquidity proxies are used
to examine whether they are the sources of H-share price discount: 1) turnover rate
and 2) bid-ask spreads.
The first liquidity proxy is turnover rate. The relative turnover rates of A-share to
H-share’s is employed in the hypothesis: TOit = (VOLA,it / TBA,it) / (VOLH,it / TBH,it),
where VOLA,it and VOLH,it are firm i’s A- and H-shares’ trading volume at time t and
- 11 -
TBA,it and TBH,it are firm i’s A- and H-shares’ tradable shares at time t. The higher the
turnover rate of A-shares to H-shares, the higher the liquidity of A-shares to H-shares.
As a result, A-shares should have a better pricing over H-shares. Thus, TOit should be
positively related to the H-share discount.
The second liquidity proxy is bid-ask spreads. The relative bid-ask spreads of
H-share to A-share’s is employed in the hypothesis: SPR it = SPRH,it / SPRA,it. The
larger the spreads of H-shares to A-shares, the higher transaction cost in H-shares to
A-shares. So, A-shares should have a better pricing over H-shares. As a result, SPR it
should be positively related to the H-share discount. (As the bid-ask spreads cannot be
obtained easily, an alternative method is used to estimate the bid-ask spreads. Corwin
and Schultz (2008) develop a new way to estimate bid-ask spreads from daily high
and low prices. The bid-ask spreads are calculated the following equation:
where Ht and Lt are the day high and day low of the share.
4.1.4. Supply of shares
In China stock market, there are limited investment opportunities and also few
- 12 -
substitutes to replace shares, so the elasticity of share demand is low. However,
investors in Hong Kong can invest various types of securities and thus the elasticity of
share demand is high. Therefore, the relative supply of A-shares to H-shares is
another proxy to examine the H-shares discount: SUPit = TBA,it / TBH,it, where TBA,it
and TBH,it are firm i’s A- and H-shares’ tradable shares at time t. The lower the value
of SUPit, the fewer the demand for H-shares to A-shares, and the price differential will
be enlarged. As a result, SUPit should be negatively related to the H-share discount.
4.1.5. Diversification benefit
With the use of the portfolio theory, foreign investors require a lower return on H
shares if the shares provide diversification benefits in their portfolio. The correlation
of H-share return and foreign market portfolio return Corr(rH,it, rMSCI,t)should be a
proxy of diversification benefits DIVMSCI,it. The higher the correlation of H-share
return and MSCI return, the lower the diversification benefits. Thus, H-shares’
demand will decrease and so does the price. Therefore, Corr(rH,it, rMSCI,t) should be
positively related to the H-share discount.
4.2. Equation of multiple regression
For convenience, it is better to convert the above hypothesis in to an equation:
DISit = a0 + a1SHAit + a2VARHit + a3SIZEit + a4TOit + a5SPR it + a6SUPit + a7 DIVMSCI,it +εit
- 13 -
5. Data
The data have been collected for the period from April 2003 to March 2008 in
respect of 53companies, 7 of which are listed on SZSE and 46 on SHSE. The data is
mainly obtained from Reuters database and supplemented by Yahoo and Sina. The
test is done on a monthly basis. A sample size of 1893 has been set. The data used are
daily closing prices, with those of H-shares being converted into Chinese yuan with
daily closing spot exchange rates. Except covariances and variances, daily numbers
are computed first, and the monthly numbers are average of daily numbers of each
month for all variables. Covariances and variances are computed using daily returns
and daily prices of each month.
The total market capitalization of each firm cannot be obtained directly. By using
the tradable shares of A-shares and H-shares, the weighted average price of the firm
can be calculated and it is then multiplied by the total number of shares issued. Thus,
a proxy of total market capitalization can be obtained. The Morgan Stanley Capital
International World Index (MSCI – World) is chosen to represent the market portfolio.
Moreover, as H-shares are traded in Hong Kong and it is reasonable to add Hang Seng
Index (HSI) to be an alternative representation of market portfolio.
- 14 -
5.1. Descriptive statistics
Detail descriptive statistics is shown in Table 4. Some numbers in the table are
worth to discuss. First, all variables have a higher coefficient of variation than
discount. This shows that the discounts of H-shares are less dispersed from the mean
than other variables. Moreover, the statistics show that not all companies experienced
price discount during the sample period, some were trading at a premium relative to
the A-shares price. But the occurrences of price premium were usually not sustainable,
so it would not affect the analysis.
The maximum relative turnover rate looks excessive. It may be explained by low
tradable volume in A-shares compare to high tradable volume in H-shares. When the
demand of A-shares suddenly increases, the relative turnover rate may also surge.
Furthermore, the coefficient of variation is still acceptable, so it is not a concern.
However, the H-share return sensitivity seems to be unreliable because the coefficient
of variation is surprisingly high. Special attention on this variable is needed when
conducting regression.
- 15 -
Tab
le 4
: D
escr
ipti
ve
stat
isti
cs o
f var
iable
s (v
alues
are
cal
cula
ted o
n a
month
ly b
asis
)
Det
ail
Var
iable
M
athem
atic
al
repre
senta
tion
M
ean
M
edia
n
M
axim
um
M
inim
um
S
td. D
ev.
S
kew
nes
s C
oef
fici
ent
of
var
iati
on
Dis
count
DIS
it
(PA
,it –
PH
,it X
t)/
PA
,it
0.4
249
0.4
270
0.8
960
-0.2
109
0.2
371
-0.1
92
0.5
58
H-s
har
e re
turn
sensi
tivit
y
SH
Ait
Cov(r
A,i
t, r H
,it)
/ V
ar(P
A,i
t)
0.0
0616
0.0
0104
2.0
9819
-0.3
0823
0.0
5506
30.1
10
8.9
41
H-s
har
e re
turn
var
ian
ce
VA
RH
it
Var
(rH
,it)
0.0
0136
0.0
0079
0.0
3407
0.0
0001
0.0
0216
6.9
13
1.5
90
Mar
ket
cap
ital
izat
ion
(mil
lion)
SIZ
Eit
SIZ
Eit
97007.7
2
12653.3
0
3292984.0
0
493.6
0
289967.0
0
5.1
93
2.9
89
Rel
ativ
e tu
rnover
rat
e T
Oit
(VO
LA
,it /
TB
A,i
t) /
(VO
LH
,it /
TB
H,i
t)
6.4
712
3.3
013
167.7
929
0.1
029
11.2
702
6.2
40
1.7
42
Rel
ativ
e sp
read
S
PR
it
SP
RH
,it /
SP
RA
,it
1.0
289
0.9
221
8.4
687
0.0
125
0.5
805
2.5
77
0.5
64
Rel
ativ
e su
pply
of
shar
es
SU
Pit
T
BA
,it /
TB
H,i
t 0.5
518
0.3
547
3.3
431
0.0
280
0.4
813
2.1
98
0.8
72
Corr
elat
ion o
f H
-sh
are
retu
rn w
ith M
SC
I re
turn
D
IVM
SC
I,it
Corr
(rH
,it,
r MS
CI,
t)
0.1
772
0.1
807
0.9
982
-0.9
184
0.2
681
-0.1
698
1.5
135
Corr
elat
ion o
f H
-sh
are
retu
rn w
ith H
SI
retu
rn
DIV
HS
I,it
Corr
(rH
,it,
r HS
I,t)
0.4
335
0.4
672
0.9
848
-0.8
980
0.2
960
-0.7
537
0.6
829
- 16 -
Table 5: Pairwise correlation
DISit SHAit VARHit SPR it TOit DIVmsci,it SIZEit SUPit DIVhsi,it
DISit 1.000 0.056 0.127 0.137 0.109 -0.113 -0.205 -0.096 -0.138
SHAit 0.056 1.000 0.254 -0.015 0.034 -0.059 -0.024 -0.029 -0.039
VARHit 0.127 0.254 1.000 0.102 -0.022 0.095 -0.022 0.034 0.131
SPR it 0.137 -0.015 0.102 1.000 -0.187 -0.035 -0.084 -0.070 0.011
TOit 0.109 0.034 -0.022 -0.187 1.000 -0.008 -0.028 0.029 -0.110
DIVmsci,it -0.113 -0.059 0.095 -0.035 -0.008 1.000 0.133 -0.013 0.474
SIZEit -0.205 -0.024 -0.022 -0.084 -0.028 0.133 1.000 -0.159 0.301
SUPit -0.096 -0.029 0.034 -0.070 0.029 -0.013 -0.159 1.000 -0.041
DIVhsi,it -0.138 -0.039 0.131 0.011 -0.110 0.474 0.301 -0.041 1.000
From Table 5, The highest correlation between two independent variables is
0.474. Multicollinearity is not likely to occur in the model. In addition, the Variance
inflation factors (VIFs) of all independent variables are less than 2, this further
consolidates that multicollinearity is not a problem in the model. However, another
two problems may arise because of the use of cross sectional model. Autocorrelation
and heteroskedasticity are two common problems when cross sectional model is
employed. In the model, both autocorrelation and heteroskedasticity are observed by
Durbin-Watson test and White test. In order to solve the problems, the Newey-West
Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation is
used in the regression.
6. Regression result and discussion
The results shown in Table 6 are estimated by OLS method and the model is
- 17 -
corrected by Newey-West Heteroskedasticity and Autocorrelation Consistent
Covariance Matrix Estimation. Model 1 includes all independent variables. Model 2 is
similar but with MSCI replaced by HSI. Model 3 includes the variables that have been
found significant by stepwise regression. The independent variables in all models are
jointly significant as all null hypotheses are rejected under F-test. All independent
variable have expected sign except SHAit and DIVmsci,it. Only SHAit is rejected at 1%
and 5% confidence level. Furthermore, the constant term is large in all models and
with high t-value, this suggests that there may be more variables to add explanatory
powers. Overall, the results show H-share return variance, relative tradable shares,
relative spread, market capitalization and supply of shares are significant determinants
of H-share discount.
In model 1 and 2, SHAit has low t-scores which indicate it is not significant. The
result is not surprised. In the descriptive statistics section, SHAit is already suspected
to be an appropriate independent variable because the coefficient of variation is too
high. In addition, the stepwise regression also shows that SHAit is not significant. This
variable may be only suitable in B-shares as done by Chakravarty, Sarkar and Wu
(1998) and Bergstrom and Tang (2001). In contrast to B-shares, the A-shares and
H-shares are trading in different stock exchanges and this may be the cause of
insignificant of SHAit. Therefore, SHAit should be dropped from the regression model.
- 18 -
Tab
le 6
: R
egre
ssio
n r
esult
(cr
oss
sec
tional
model
, m
onth
ly d
ata,
sam
ple
siz
e:1893)
(model
corr
ecte
d b
y N
ewey
-Wes
t H
eter
osk
edas
tici
ty a
nd A
uto
corr
elat
ion C
onsi
sten
t C
ovar
iance
Mat
rix
Est
imat
ion)
Factors/M
odel
Expected sign
1
2
3
4
5
6
7
Const
ant
term
0.4
028
0.4
180
0.4
031
0.3
627
0.3
444
0.3
250
0.4
059
(15.6
9**)
(15.0
2**)
(15.7
4**)
(16.5
5**)
(16.3
8**)
(15.2
1**)
(26.5
9**)
Inform
ation asymmetry
SH
Ait
- 0.0
3545
0.0
4415
(0.4
4)
(0.5
7)
VA
RH
it
+
13.6
769
13.9
419
13.9
195
13.3
706
13.8
937
12.5
975
13.9
635
(4.4
7**)
(4.3
8**)
(4.8
9**)
(4.7
8**)
(4.9
4**)
(4.5
3**)
(4.8
8**)
Liquidity
TO
it
+
0.0
02755
0.0
02581
0.0
0276
0.0
02737
0.0
02899
0.0
02935
(4.3
2**)
(4.1
4**)
(4.3
3**)
(4.2
7**)
(4.3
6**)
(4.3
8**)
SP
R i
t +
0.0
49192
0.0
50777
0.0
49044
0.0
53556
0.0
59653
0.0
61959
(4.2
1**)
(4.3
3**)
(4.2
2**)
(4.5
2**)
(4.9
8**)
(5.1
1**)
Diversification
DIV
msc
i,it
+
-0.0
8342
-0
.08403
-0.0
8429
-0.1
0483
(-3.8
3**)
(-
3.8
9**)
(-3.9
0**)
(-4.7
9**)
DIV
hsi
,it
+
-0
.07428
(-
3.0
2**)
Market Capitalization
- 19 -
SIZ
Eit
- -0
.00000016
-0.0
0000015
-0.0
0000016
-0.0
0000014
(-3.6
0**)
(-3.2
6**)
(-3.6
1**)
(-3.4
3**)
Supply of shares
SU
Pit
- -0
.06312
-0.0
6291
-0.0
6331
(-2.7
3**)
(-2.6
8**)
(-2.7
4**)
Adj
R2
10.7
0%
10.6
0%
10.7
4%
9.2
0%
6.2
5%
4.9
1%
1.5
7%
- 20 -
Another issue is that the diversification benefit has an opposite sign compared
with the hypotheses expected sign. And the t-value is significant at 1% confident level.
If the sign is reverse, it means that the higher the correlation between H-share return
and MSCI return, the lower the H-share discount. Even the diversification benefit is
low, people still buy H-shares and lower the price discount of H-shares. This problem
seems to be contradictory to the portfolio theory. However, if we consider the
macro-economy of Hong Kong in that period, the above problem can be explained
easily. The sample period is from April 2003 to March 2008. In the first half of 2003,
the Hong Kong stock market was plunged by the SARS problem. Everyone was afraid
of the killing disease and the confident level of the public dropped to a trough. So, the
stock market experience massive selling force. In the second half of 2003, the
problem of SARS was nearly solved and people’s confidence recovered to a normal
level. As a result, the stock market bottomed and recovered from the over-sold
position during SARS. After that, the stock market rose steadily in the coming years.
In July 2005, the China government suddenly announced that the appreciation of
RMB and the RMB would be linked with a basket of foreign currency. As the
H-shares are denominated in HKD but the assets are settled in RMB, the appreciation
of RMB will have a positive impact on the stock price. Therefore, the stock market
rose kept rising from 2005 to 2007. With these two special incidents, the capital gain
- 21 -
in this period has overwhelmed the diversification benefit. Not surprisingly, this is the
reason to explain the negative relationship of H-discount and diversification benefit.
Other than these two variables, the others have significant explanatory powers to
the H-shares discount. The highest adjusted R2
among the models is 10.74%. Looking
at the increment in adjusted R2
from model 3-7, relative turnover rate, relative spread
and market capitalization are strong factors in explaining the cross-sectional price
differential of H-shares. The adjusted R2
may be small and there should be more
explanatory variables to explain the H-share price discount. However, some of the
variables are difficult to quantify such as political factors, investment behaviors
between domestic and foreign investors, manipulation of shares, insider activities and
more.
7. Conclusion
This paper studies the impact of market segmentation on stock prices. A number of
examples are shown that foreign shares experience a price premium relative to the
domestic shares. However, China B-shares give a distinct example that foreign shares
are trading at a price discount relative to the domestic shares. Next, H-shares also
experience a price discount and the average daily discount is 38% from April 2003 to
March 2008. With the interest of what factors are causing the price discount, a cross
- 22 -
sectional model is used to analyze 53 dual-listed A- and H-shares. The result shows
that the price discount can be explained by the volatility of H-share return, relative
tradable share, spread and supply of shares between A- and H-shares and market
capitalization. There should be other explanatory variables of H-shares discount (such
as political factors, investment behaviors between domestic and foreign investors,
manipulation of shares and insider activities) as the R2
is only 10.74% and the
intercept of the regression equation is high. As the A- and H-share markets become
more integrated (government policy likes QDII and QFII), more explanatory factors
will be available to explain the price discount in the future.
References
[1] Bailey, W., 1994. Risk and return on China’s new stock markets: Some preliminary evidence.
Pacific-Basin Finance Journal, 2, 243-260.
[2] Bailey, W., Jagtiani, J., 1994. Foreign ownership restrictions and stock prices in the Tai capital
market. Journal of Financial Economics, 36, 57-87.
[3] Bergstrom, C., Tang, E., 2001. Price differentials on different classes of stocks: Empirical study
on the Chinese stock market. Journal of Multinational Financial Management, 11, 407-426.
[4] Chakravarty, S., Sarkar, A., Wu, L., 1998. Information asymmetry, market segmentation and the
pricing of cross-listed share: Theory and evidence from Chinese A and B shares. Federal Reserve
Bank of New York. Research Paper No. 982.
[5] Corwin S., Schultz P., 2008. A simple way to estimate bid-ask spreads from daily high and low
prices. Working Paper, http://ssrn.com/abstract=1106193
[6] Domowitz, I., Glen, J., Madhavan, A., 1997. Market segmentation and stock prices: Evidence
from an emerging market. Journal of Finance, 52, 1059-1085
[7] Eun, C.S., and S. Janakiramanan, 1986. A model of international asset pricing with a constraint
on the foreign equity ownership. Journal of Finance, 41, 1025-1037.
[8] Hietala, P.T., 1989. Asset pricing in partially segmented markets: Evidence from the Finnish
market. Journal of Finance XLIV (3), 697-718.
- 23 -
[9] Li, Y., Yan, D., Greco, K., 2006. Market segmentation and price differentials between A shares
and H shares in Chinese stocks markets. Journal of Multinational Financial Management, 16,
232-248.
[10] Mei, J., Xiong, W., 2004. Speculative trading and stock prices: An analysis of Chinese AB share
premia. Princeton University, mimeo
[11] Newey W.K., West K. D., 1987. A simple, positive semi-definite, heteroskedasticity and
autocorrelation consistent covariance matrix. Econometrica, 55, 703-708.
[12] Poon W., Firth M., Fung H., 1998. Asset pricing in segmented capital markets: Preliminary
evidence from China-domiciled companies. Pacific-Basin Finance Journal, 6, 307-319.
[13] Stulz, R., Wasserfallen, W., 1995. Foreign equity investment restrictions, capital flight and
shareholder wealth maximization: Theory and evidence. Review of Financial Studies, 8,
1019-1057.
[14] Sun, Q., Tong, W.H.S, 2000. The effect of market segmentation on stock prices: The China
syndrome. Journal of Banking and Finance, 24, 1875-1902.
[15] Wang, S., Jiang, L., 2004. Location of trade, ownership restrictions, and market illiquidity:
Examining Chinese A- and H-shares. Journal of Banking and Finance, 28, 1273-1297
- 24 -
- 24 -