Where does the price spread between
A-shares and H-shares come from?
Meier Fu (10504923)
Thesis Supervisor: Razvan Vlahu
Track of Finance and Organizations
Faculty of Economics and Business
University of Amsterdam
1. Introduction
According to the Efficient Market Hypothesis, in a perfect capital market, a stock price simply presents all the relative available information (Fama, 1970). As a result, if two financial securities are issued with the same underlying value, which depends on the same stream of future cash flows, have the same riskiness and the same discount rate, their prices should be identical regardless of trading locations or any other differences in market characteristics (Steven and Li , 2003). However, the current international capital market is far to being perfect. That is to say, the Market Segmentation Theory, which states that there could be a price spread between the identical assets in various trading locations, is still applicable. Therefore, in order to obtain the potential diversification opportunities brought by price spreads, it has been common that many companies have a tendency to issue and list their stocks synchronously on several different exchanges,.
Currently, China divides its stock market into three independent parts, known as A-shares, B-shares and H-shares. Chinese capital market is a relatively insulated market: B-share and H-share markets are regarded as the major channels for domestic companies to make use of stocks to take in the introduction of foreign capital and for foreign investors to utilize stocks to invest in Chinese market. Because of its particular ownership structure, market structure and investors’ structure, compared to other countries’ situations of market segmentation, the segmented market of China has some specific characteristics, both from a theoretical and empirical point of view. For example, in the Chinese stock market, prices of B-shares and H-shares are usually lower than that of the A-shares of the same underlying asset, which is contrary to the findings of the research on market segmentation. As a peculiar characteristic of the financial market of China, many Chinese companies synchronously issue both A-shares, which are restricted to Mainland China investors (i.e., traded in their home financial market), and H-shares, which are restricted to Hong Kong and other international investors (i.e., traded in ‘foreign’ financial market). H-share, which is denominated in Renminbi but traded with Hong Kong dollars, is a kind of special stock of Mainland firms approved by the Stock Exchange of Hong Kong. All companies that issue both A-shares and H-shares belong to fundamental
industries of China, such as steel, banks and communication industry. H-share market, as a special part of the Chinese financial markets, is of a great importance. Actually, on the basis of Market Segmentation Theory, as expected, available data and researches have shown that there is a significant price spread between A-share and H-share stocks.
In this thesis, I define my research question as the potential influential factors for the price spreads of A-shares and H-shares for those Chinese companies who issue both. I investigate what are the possible factors of time-varying H-share price discount relative to the corresponding A-share of 25 dual-listed companies, over the period January 2013 to December 2014. Potential variables are considered such as market liquidity, relative risk aversion and company size. An empirical investigation is conducted using information on stock prices, trading volumes, numbers of shares outstanding, and so on.
This thesis is structured as follows: Sections 2 discussed the related literature. Section 3 presents the research methodology and provides the description of applied model and the main hypothesizes to be tested. Data is described in Section 4. Section 5 contains the results and Section 6 concludes.
2. Literature review
Many investors are interested in foreign equity markets, especially in emerging countries, in order to seek for higher returns and international diversification. As a result, governments of many emerging countries are likely to make some investment restrictions to their stock markets during their early development stage (Domowitz, Glen, and Madhavan, 1997). These restrictions could be generally classified into two different categories: i) the restrictions to investors, such as limiting foreign investors to enter domestic capital market; and ii) the restrictions to capital, for example, the government of emerging countries may draw up a maximum ratio of shareholding of listed companies particular for foreign investors. These restrictions, which are also called investment barriers, could lead to a market segmentation and therefore bring a decreasing gain on international diversification (Bailey, 1994). Compared to Hong Kong, the financial market in Mainland China is relatively immature because the Chinese financial market set up much later. Like what most emerging
countries do, Chinese government also set some investment barriers as well. Stocks in A-share market could only be bought and traded with Renminbi and foreign investors are not allowed to get involved. From February 19th 2001,
B-share has been opening to international investors. In 2002, establish of Qualified Foreign Institutional Investors (QFII), which allowed international institutional investors to invest in Chinese Renminbi denominated financial market on a selective basis, took the lead to break the situation of complete segmentation of A-share and H-share market; international investors started to be able to invest in A-share market through QFII system indirectly. Then in 2007, Qualified Domestic Institutional Investors (QDII) policy allowed Chinese domestic investors to invest abroad with foreign currency, which showed China’s effort to further internationalize its domestic financial market.
Since the eightieth decade of last century, scholars have showed empirically that in most countries with segmented markets, for dual-listed stocks foreign shares usually have a price premium compared to the corresponding domestic shares. Hietala (1989) found that domestic investors are able to obtain the domestic stocks with a lower price than foreign investors. They use the stock prices of Finland firms, given that domestic investors could only hold domestic stocks while foreign investors were allowed to hold both domestic and other foreign stocks. Bailey and Jagtiani (1994) investigated the financial market in Thailand and found that unrestricted stocks usually have a price premium of 19% compared to restricted stocks, for domestic investors. Domowitz, Glen and Madhavan (1997) discussed the existence of the multi-level stocks in emerging market of Mexico over the period from January 1990 to December 1992..
At present, there are several explanations for the price spread between foreign and domestic shares of dual-listed companies. Differential Valuation Model describes that there are four aspects of diversity that may be responsible for the price spread between domestic and foreign investors. First, by researching Chinese stock market, Sun and Tong (1999) pointed out that the expected growth rates between domestic and foreign investors are different. Domestic Chinese investors are optimistic with China’s economy while foreign investors are comparatively more prudent. Thus, for stocks of the same listed firm, the expected growth rate of foreign investors is lower than that of Chinese
investors, and therefore foreign investors are only willing to pay for the stocks with a lower price. Second, foreign investors are usually able to hold a higher degree of diversification with their investments by investing an international portfolio. As a result, with extra benefit by dispersing risk, foreign investors will ask for a lower risk compensation, and therefore lead to a price premium. That is, as Stulz (1981) describes, in the case there is no restriction for international capital investment, the magnitude of risk compensation for a risky asset is only relative with the covariance between return of the asset and of world market portfolio. The third possible factor is the prospective difference among demand elasticity of various financial markets. Domowitz, Glen and Madhavan (1997) study the stock market in Mexico and found evidences showing that change in shares supply has great explanatory power for price discount/premium. Finally, the last explanation is the difference of attitudes towards potential risk, which we may also call the risk aversion. Ma (1996) used data on Chinese stock market and found that there are only very limited investing channels for domestic investors in Mainland China. Thus there is supposedly comparatively lower demand elasticity and stronger speculation actions taken by domestic investors for A-shares in Mainland China, which drive an increasing price of A-share. The Information Asymmetry Theory gives another explanation for the price discount/premium of foreign stocks. The original Capital Asset Pricing Model assumes that all investors own the same information and have a return in accordance with expectations. Nevertheless, the Information Asymmetry Theory suggests that it is costly to obtain certain information and it could be partly or even completely distinct for different investors to comprehend the information. This kind of distinction could lead to different prices with the same asset (Bailey, 1994). In addition, the Liquidity Hypothesis proposes that investors have to pay a higher transaction cost in a lower liquidity market than in a higher liquidity market, and therefore they ask for a lower price as compensation (Amihud and Mendelson , 1986).
3. Methodology
This thesis integrates both theoretic and empirical investigation to try to approach a more scientific and accurate conclusion. Firstly, it pays attention to
the available research findings about price spreads of multi-listed corporations. Then combine them with the collected empirical data, making use of STATA13. According to the available researches, considering the various characteristics of each factor as well as the availability of obtaining data, this thesis discusses several possible factors from specific aspects, named as the liquidity index, relative risk aversion index, company size index and the issued location of A-shares in Mainland China. To describe the variables sequentially, the dependent variable is defined with a formula calculated by available data firstly; then two main explanatory variables are defined,, followed by the description of the other two independent variables.
i) Dependent variable: H-share price discount index
HPDi,t = , i=1,2,…,25,
where PAi,t is the closing price of dual-listed company i on Shanghai
(/Shenzhen) Exchange Stock at time t; PHi,t is the closing price of
dual-listed company i on Hong Kong Exchange Stock at time t; r is the exchange rate of Hong Kong dollars to RMB (i.e., how much HK$ per RMB). Though r is a constantly changing number, it seldom significantly deviates from 0.8 with a significant level of 5% during our sample period. Hereby I assume r=0.8 and it is constant during the sample period.
In an integrated financial market, the Law of One Price should hold. In other words, price spreads only exist in a segmentated market. Generally, the segmentation stock market is shown as the difference of pricing in various markets, which caused by the obstacles of capital movement and the trading environmental differentiation. Market segmentation may come in several forms, among which the different stock prices of dual-listed companies in respective segmented markets is the one of the main forms.
ii) Explanatory variables:
(a)Main explanatory variable 1: Liquidity index LQi,t = , , , i=1,2,…,25, t Ai t Hi t Ai P P r P , , , − •
where VOL represents the trading volume of shares of company i at time t; H and A represent the data in the Hong Kong stock market and Mainland China stock market respectively.
We set up a hypothesis 1) with decrease of the liquidity of A-share or increase of the liquidity of H-share, the H-share price discount shrinks. Generally speaking, investors tend to invest in assets that have a relatively stronger circulated rate, because it is easier for those assets to be liquidated with a lower transaction cost. Investors would like to obtain an extra compensation if it is costly for the stocks to be liquidated. In the other words, for the assets with a low circulation, investors would make up for the extra transaction cost by asking for a higher rate of return with lower trading prices. Since A-share is the main (or, even the only one) investment for investors in Mainland China, while H-share is only one of many investment choices for international investors. The market-delivered liveness of A-share is much higher than that of H-share, which may lead to the relative price discount for H-share.
(b)Main explanatory variable 2: Relative risk aversion index RVOLAi,t = ,
, , i=1,2,…,25,
where VOLAi,t = , ,
,
, within which , is the highest
price of the day noted by t, , is the lowest price of t and Pi,t-I is the
close price of the day before time t.
This thesis makes a hypothesis 2) the more A-share investors prefer high risk, the higher H-share price discount.
How an investor decides which stock to invest in? This thesis supposes an investment decision is the visibly final act of a series of investors’ invisible preferences and comprehensions towards what they are able to get that influence the behaviors of investors. Because of various cultures and economic environments, the thoughts of investing between Chinese and other foreign investors are certainly different. From a theoretic perspective, the difference between investment
thoughts shows up in risk aversion. On one hand, the Mainland Chinese investors are basically retail investors with relatively irrational investing decisions and stronger speculation. This kind of irrationalness reflects in that they are more likely to invest in stocks with higher risk and return (Errunza and Losq, 1985). They are willing to take more risk in order to obtain more money in short term. On the other hand, international investors are more rational in their investment decisions. They may ask more compensation for the potential high risk. That is why the H-share price discount exists.
(c)Control variable 1: Company size index CSi,t = PAi,tSAi,t + r PHi,tSHi,t, i=1,2,…,25,
where Si,t is the number of shares outstanding of firm i at time t.
This thesis holds a hypothesis 3) foreign investors ask less return on the H-share of a bigger company than that on a smaller one. In other words, a larger sized company is assumed to have a lower H-share price discount.
Generally speaking, the bigger the company size is, the more multiple the information channels that company is able to access to. Famous listed companies are required to pay more attention to the accuracy and timeliness of information disclosure. Thus, it would be easier for investors (and especially for foreign investors) to obtain better knowledge of a relatively bigger company than a smaller one. Bailey and Jagtiani (1994) show that larger companies are more attractive for investors than smaller ones since more comprehensive information could be provided,. As French and Poterba (1970) argues, investors avoid investing in assets which they have limited information and experience, because it costs more to acquire or produce necessary information. As a result, there should be a lower demand for stocks of relative smaller listed companies and thus a price discount.
(d)Control variable 2: Location of trading in Mainland
Defined as a dummy variable MKTi : =1 is the stock is traded in
Shanghai and =0 if the stock is traded in in Shenzhen
This thesis put forward a hypothesis 4) companies issuing their
A-shares in Shanghai have a higher H-share price discount than that issuing their A-shares in Shenzhen.
By now, there are no previous articles discussed the possible influence of the locations of A-share issuing in Mainland China. Therefore, this variable could be seen as one innovation point of this thesis. There are some reasons of why this variable is being considered. On one hand, Shanghai Stock Exchange (SHSE) is the first stock exchange in Mainland China. At present, SSE still has the largest number of listed companies, issued stocks volume, total market value and total value of securities transactions. On the other hand, Shenzhen Stock Exchange (SZSE) locates near to Hong Kong and thus international investing institutions in Hong Kong might affect investors’ investing behaviors in Shenzhen more than that in Shanghai. Therefore, this thesis assumes the location of trading of A-share as a potential explanatory variable.
iii) Error term: εi, i=1,2,…,25
To sum up, the regression equation can be written as:
HPDi,t=β0+β1LQi,t+β2RVOLAi,t+β3CSi,t+β4MKTi+εi, i=1,2,…,25
In order to avoid the multicollinearity problem of time-series analysis and the heteroscedasticity problem of cross-sectional analysis, I use panel data regression model . An econometric model set by panel data can obtain unbiased estimations by controlling the explanatory variables to affect the dependent variable. In general, a panel data model could be shown as:
yit=αi+βixit+μit, i=1,2,…,N; t=1,2,…,T
where xit=(x1it, x2it,…, xkit) is the vector of explanatory variable, and βit=(β1it,
β2it,…, βkit) is the parameter vector. In addition, k is the number of explanatory
variables, t is the number of time periods, N is the number of cross sections and μit is the random error.
4. Empirical Data
Because the magnitude of H-share price discount varies with time periods, this thesis mainly focuses on the latest two years’ situation. In this thesis, I use
pairs of daily prices, trading volume, numbers of shares outstanding and bid-ask spread data for companies that issue both A-shares and H-shares from 4th ???
MONTH 2013 to 31st ??? MONTH 2014. Excluding the companies that have a
trade suspension for a long time or have a too-short trade time during the sample period, I finally choose 25 dual-listed companies for data collecting. 18 of them are listed in Shanghai Exchange and the other 6 are in Shenzhen. Data on stock prices and trading volumes are obtained through the daily database of the Stock Exchanges of Hong Kong, Shanghai and Shenzhen. Table 1 below lists the names of 25 dual-listed companies in the sample and the basic statistics of their daily H-shares price discount:
Stock name Maximum
price discount Minimum price discount Average price discount Standard Deviation Agricultural Bank of China 16.466% -9.454% 3.506% 0.183287 Angang Steel 14.355% -23.177% -4.411% 0.265389 Beijing N Star 59.309% 43.767% 51.538% 0.109902 China Oilfield 50.386% 22.331% 36.358% 0.198379 China Railway 45.451% -16.408% 14.522% 0.437409 Dalian Port 56.561% 48.834% 52.697% 0.054640 Shandong Chenming 33.248% 28.846% 31.047% 0.031132 Chongqing Iron 66.154% 58.919% 62.536% 0.051159 Citic Bank 38.870% 12.103% 25.487% 0.189268 Eastern Airline 42.548% 25.598% 34.073% 0.119859 First Tractor 65.036% 35.910% 50.473% 0.205954 Guangshen Rail 33.556% 18.111% 25.834% 0.109213 Zhejiang Shibao 87.957% 78.564% 83.260% 0.066418 Yanzhou Coal 60.260% 40.333% 50.296% 0.140902 Huaneng Power 18.481% 6.338% 12.409% 0.085862 Zijing Mining 48.480% 40.876% 44.678% 0.053767 Jiangxi Copper 42.577% 33.253% 37.915% 0.065929 PetroChina 37.057% 0.176% 18.616% 0.260792
Shandong Molong 76.770% 71.727% 74.248% 0.035660 Xinjiang Goldwind 45.418% 32.232% 38.825% 0.093238 Kunming Machine 65.011% 64.699% 64.855% 0.002203 Maanshan Iron 53.716% 0.741% 27.228% 0.374590 Shangdong Xinhua 62.855% 60.105% 61.480% 0.019444 Dongfang Electric 45.164% 3.936% 24.550% 0.291522 Haitong Securities 35.220% -0.254% 17.483% 0.250834
Table 1: Daily price discount of H-shares
From Table 1, it can be seen that the average daily H-share price discounts of these 25 stocks are from -4.411% to 83.260%. Specifically, Angang Steel presents a lowest H-share price discount of -4.411% while Zhejiang Shibao has a highest one of 83.260%. It is obvious that gaps among the average H-share price discounts of these 25 stocks are wide. I divide them into 4 groups by their various levels of average price discounts. In detail, there are 6 stocks with an average price discount lower than 20%, which means that the prices of A-share and H-share are quite close. Another 9 stocks’ average H-share price discounts are between 20% and 40%. The third group is composed of 5 stocks whose price discounts are between 40% and 60%, which are bigger than that of previous ones but still hold their respective characteristics. The remaining 5 stocks have a H-share price discount higher that 60%, whose A-share prices are apparently higher than H-share prices. As a supplement, there is an atypical exception, Angang Steel, which has a negative H-share price discount. In Table 2 below, the statistical analysis of average H-share price discount shows that firms issuing A-shares in Shenzhen have a wider range of average H-share price discounts than those in Shanghai.
Average daily H-share price discount A-share issued in Shanghai (19) A-share issued in Shenzhen (6) Total sample (25) ≤20% 5 1 6 20% - 40% 7 2 9 40% - 60% 5 0 5 ≥60% 2 3 5 Mean 34.48% 47.41% 37.59%
Median 34.07% 50.15% 36.36%
Maximum 64.86% 83.26% 83.26%
Minimum 3.51% -4.41% -4.41%
Table 2: Statistical analysis of average H-share price discount
On the other hand, because of the differences between holidays, regional policies and other reasons, the numbers of trading days of Mainland China market and Hong Kong market are not exactly the same. For example, Christmas is a statutory legal holiday in Hong Kong, but not so in Mainland China. Therefore, after filtrating, finally the time-series coverage is 428 contemporaneous trading days of all selected dual-listed companies during 4th Jan 2013 to 31st Dec 2014.
Data summary is shown in Table 3:
Variables Number of observations Mean Standard Deviation Min Max HPDi 10700 0.2888265 0.287532 -0.454768 0.885786 LQi 10647 0.9443438 1.586949 0 25.83744 RVOLAi 10672 1.409241 1.114306 0 47.90419 CSi 10700 1201.533 2977.875 13.72569 18652.56 MKTi 10700 0.76 0.427103 0 1
Table 3: Descriptive statistics
From the data summary table, it can be seen that there are in total about 25 (companies) * 428 (common trading days) observations for each variable, as stated above. Some important messages could be read out. To be more specific, firstly, the mean of HPDi is 0.2888, which illustrates that there is indeed, in
average, a price discount for H-shares to the corresponding A-shares. Secondly, the mean value of variable LQi, 0.9443, shows that the trading volumes in Hong
Kong and Mainland China are roughly same.
5. Results
As mentioned before, this thesis uses panel data analysis run in STATA13. Below is the OLS regression of H-share price discount index (HPD) against liquidity (LQ), relative risk aversion (RVOLA), company size (CS) and location of trading in Mainland (MKT) for time-series effect:
Independent variables Dependent variable: HPDi (1) (2) (3) (4) LQi -0.02427 (0.0017409) -0.01987 (0.001815) 0.0086 (0.0019436) 0.006137 (0.001897) RVOLAi -0.02149 (0.0025872) -0.02762 (0.0024762) -0.03047 (0.0024162) CSi -3.2E-05 (9.94E-07) -2.7E-05 (9.92E-07) MKTi -0.14 (0.0061622) Intercept 0.311589 0.337678 0.357944 0.469346 R-Squared 0.2179 0.2243 0.3115 0.3563
Table 4: OLS regression result from STATA
As the Panel Data Model we set in the third part:
HPDi,t=β0+β1LQi,t+β2RVOLAi,t+β3CSi,t+β4MKTi+εi, i=1,2,…,25,
where i indicates each firm in our samples and t indicates observations by day for the period between 4th Jan 2013 to 31st Dec 2014, Table 4 displays the
regression results by respective estimate of coefficient, and in the parentheses are the heteroskedasticity-consistent standard errors of each parameter estimate.
Column (1) contains our key results for the regression model (all under 5% significant level). R-Squared is 0.3563, says that about 35.63% of the change of H-share price discount could be explained by the effect factors this thesis argued. To confirm whether the linear correlation between dependent variable and explanatory variables is significant, F-test is provided. Given the null hypothesis H0: β1=β2=β3=β4=0 and the significant level α=5%, when the degree of freedom k=4 (there are 4 listed potential explanatory variables) and n-k-1=25-4-1=20, we could find it in the F-distribution table that the critical point of F-value is F=3.84. However, through STATA13, we collect the F-statistics is 4.32, thus the null hypothesis is rejected. Therefore, the linear relationship between dependent and independent variables is in general significant.
As for the estimates of coefficients, LQ, the liquidity index, has an estimate of coefficient 0.006137, which is significantly larger than 0. This result is consistent with our hypothesis and indicates that the stocks with a higher liquidity will hold a less price spread between their issued shares in Mainland China and Hong Kong. This result shows that the difference of the demand elasticity between A-shares and H-shares is influential to the price discount of H-share relative to A-share to some extent. To be more detailed, because of the relatively low demand elasticity in Hong Kong market, the supply of H-shares is increasing and thus reduces the price of it.
RVOLA is significantly smaller than 0, describing a negative relationship between investors’ risk aversion and the price discount. This is also consistent with what we have predicted. If investors are likely to evade risk, H-share price discount will be lower. Moreover, the effect of company size, CS, is negative and statistically significant, which means that the bigger the size of a company, the smaller the extent of H-share price discount of that company. In other words, the price spread between A-share and H-share of a firm is smaller if this firm is a relatively larger one with a better disclosure of information for domestic as well as international investors. Therefore, the observed price discount is statistically lower for a larger company. This result is also consistent with what Bailey and Jagtiani (1994) found by researches in Thailand financial market.
MKTi is a dummy variable marking the issued location of A-shares. The
estimate of coefficient, -0.14, indicates that the firms issuing their A-shares in Shanghai have an averagely 14% lower H-share price discount compared to those in Shenzhen. This result runs an opposite way from this thesis’s previous assumption. This is possibly due to the Shanghai’s internalization process as one of important financial centers in the world.
6. Concluding Discussion
This thesis discusses the price discount of H-share issued in Hong Kong compared to the corresponding A-share issued in Mainland China. Four diverse factors are put forward to explain the existence of H-share price discount. The results suggest that market liquidity, relative risk aversion of investors, company size and locations of A-share are all post an impact to the magnitude of H-share
price discount.
With more and more companies choosing to issue A-share in Mainland China and H-share in Hong Kong simultaneously, the problem of the price spread between A-share and H-share is attracting increasing attention. However, as the accelerating process of Chinese financial market internationalization, the implementation of QFII and the growing call for QDII, the status of segmented Chinese stock market have been gradually bucked. Theoretically speaking, since market segmentation is generally characterized by the price spread between the identical stocks traded in various locations, it is necessary to eliminate the price spread first in order to finally achieve an integrated market. As this thesis discussed before, market liquidity, investors’ risk aversion and information asymmetry (company size) may be able to act as starting points for changing the segmentation status quo. Therefore, this thesis put forward several suggestions about how to facilitate a more integrated Chinese financial market with a lower H-share price discount:
i) Enlarge the degree of openness of Chinese financial market. Our results show that market liquidity is in direct proportion to the H-share price discount. The primary cause of price spread is market segmentation (Domowitz , Glen and Madhavan , 1997). The Renminbi does not have a full convertibility under capital account, thus the investments of Chinese domestic investors are restricted to some extent. To solve this, Chinese government may loose foreign exchange controls, continue to increase the opening-up in capital market for the sake of integrating the financial market of Mainland China and Hong Kong (also other immature emerging financial markets). In particular, further process of implementing QDII is able to mitigate the artificially separated Chinese financial market and reduce H-share price discount by arbitrage. For domestic investors in Mainland China, the implementation of QDII definitely broadens their investing channels and enriches the investing tools. As a result, enthusiasm for investments is released and demand elasticity is improved. For Hong Kong and foreign investors, with the decrease of the price spread between A-share and H-share, they will hold stronger confidence for the Hong Kong financial market and lead to a further higher H-share price.
investors influences their investing behaviors to a great extent. On one hand, domestic investors in Mainland China are short of correct investment philosophy. They tend to have relative strong speculative mindset and risk preference toward financial market. This kind of mindset is not only harmful for narrowing the price spread between A-share and H-share, but also harmful for the sound development of the whole Chinese financial market. On the other hand, Hong Kong and international investors are relative more rational, so a moderate opening A-share market may lead to domestic investors’ rational investment by imitating the proper investments behaviors of foreign investors. However, of course, the imitated roles that foreign investors are playing are very limited. One important sign of a mature financial market is the diversification of market participants and the predominance of institutional investors (Domowitz, Glen, and Madhavan, 1997). Therefore, it is crucial to cultivate a number of rational institutional investors in Mainland China by, for example, training more financial talents by colleges and universities or offering more policy supports by governments. The raising proportion of rationally institutional investments does benefit to strengthening risk awareness of investors, preventing excessive speculation and promoting the financial market standardization.
iii) Diminish the information asymmetry. This thesis indicates that the information asymmetry has some explanatory power to the H-share price discount; international investors usually only get in touch with limited info windows and thus the pricing of H-share based on this information is reduced. Merton (1987) argues that investors are only willing to trade with risky assets that they are familiar. So ameliorating the information asymmetry is an indispensable way to make the price spread between A-share and H-share shrink. Primarily, the information disclosure system of listed companies should be optimized, in order to relieve the information asymmetry between listed companies and H-share investors. Listed companies with issued H-shares should establish multiple channels of public information disclosure, let more investors (especially international investors) get a closer look to the enterprises’ current situation and build up their confidence. In addition, normalization of price signaling system is also a key concept in correcting information asymmetry. If A-share price could reflect the information more reliably and effectively, foreign
investors are able to form more rational expectations by price signaling system to make up for the lack of information. In other words, with a well-functioning price signaling system, foreign investors could predict the H-share price by the fluctuations of the prices of corresponding A-share. As a result, prices and returns of H-share and A-share will tend to be close and steady.
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