Academic journal article International Journal of Business

Short-Term Dynamic Transmission and Long-Term Foreign Share Discount: Evidence from the Chinese Stock Markets

Academic journal article International Journal of Business

Short-Term Dynamic Transmission and Long-Term Foreign Share Discount: Evidence from the Chinese Stock Markets

Article excerpt

ABSTRACT

This study concerns the information transmission between Chinese A and B share classes, and the discount effect of B shares. We first examine the short-run dynamic transmission of information flow between A and B shares using a bivariate GARCH framework that jointly models the first and second moment of stock returns from both share classes. We find that there are significant positive return transmissions and volatility spillovers across Chinese A and B shares, and that the information flow transmissions from B to A shares are stronger than the transmissions from A to B shares. However, empirical results show that cross-market volatility spillover effects are still much weaker than the A B share own-market volatility spillover effects, suggesting that A and B share prices may be driven by different underlying forces. We then formulate an empirical model to investigate the financial determinants of long-term foreign B share price discount. Our results show a significant negative relationship between B share percentage price discount and company annual earnings, suggesting that foreign investors tend to react more strongly to weakness in the listed company's ability to generate earnings. Company ownership structure and capital structure are also found to have significant relationship with the B share price discount.

JEL: G12, G14, G15

Keywords: Information Transmission, Bivariate GARCH; Earnings, Chinese Stock Market; Market Segmentation

I. INTRODUCTION

As part of its continuing efforts to develop a socialist market economy, China opened the Shanghai Stock Exchange (SHSE) in December 1990 and the Shenzhen Stock Exchange (SZSE) in July 1991. Both exchanges operate in a continuous auction environment with computerized matching system, and stocks are prohibited from cross listing on both exchanges. Upon approval by the State, Chinese companies can issue two types of shares at SHSE or SZSE to raise equity capital: "A" shares are owned and traded by Chinese domestic investors, and "B" shares are owned and traded by foreign investors in US dollars at SHSE or HK dollars at SZSE (1). Serious market fragmentation is a distinct feature of the emerging Chinese equity market, although in principle, creating a hierarchy of share classes goes against the equality of ownership within a corporation.

In recent years, the segmentation of the Chinese stock markets has attracted a great deal of research interests from financial economists. Most of the research effort so far has focused on the linkage and interactions of A and B share markets in terms of the conditional first moment of the distribution of returns. For example, Chui and Kwok (1998) applied a Simultaneous Equation framework to examine the mean transmission between A and B share returns, and found that first moment return transmissions exist from B share to A share and, to a lesser extent, from A share to B share. These studies ignored, however, the heterogeneity of security returns and the cross-market spillover of A and B share return volatilities (second moment transmission).

From a market microstructure perspective, price movement depends on the arrival of new information and the process that incorporates this information into market prices (2). During the trading period, informed traders may arrive at each market with private information regarding the value of financial assets. The arrival of new private information thus induces a sequence of trades that reveal the pricing implication of the latent information. Therefore, the information content of price is reflected in both the first and the second conditional moments of stock returns (conditional mean and conditional variance). In this study, we examine the short-run dynamic information transmission between the Chinese A and B share markets using a Bivariate Generalized Autoregressive Conditional Heteroskedasticity (GARCH) framework, which simultaneously models the return transmission and volatility spillover across the two markets. …

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