CROSS-AUTOCORRELATION BETWEEN A SHARES AND B SHARES IN THE CHINESE STOCK MARKET

Listed companies in China, upon meeting certain requirements, can issue two types of shares: A shares and B shares. Local investors in China can only buy and sell A shares, while foreign investors can only buy and sell B shares. We argue that foreign investors may receive news about China faster than domestic Chinese investors because of information barriers in China. Since foreigners participate in the B-share market, the price movements of B shares should reflect the common information that the foreigners have. Rational A-share investors can therefore condition their trading decisions on the previous price movements of B shares. As a result, returns on B shares should lead the returns on A shares. Using daily prices of A and B shares, we demonstrate that returns of B shares are correlated with those of A shares and that this correlation depends on the information transmission mechanism at work. The pattern of the asymmetric cross-autocorrelation is robust to the inclusion of lagged realized returns and trading volumes.     

Stock Returns and Volatility under Market Segmentation: The Case of Chinese A and B Shares

In most countries where firms list separate shares for trading by foreign and domestic investors, the prices of the foreign shares tend to be higher. In China, the reverse tends to be true. In this paper, we would like to focus on the information content in lagged premiums of Chinese A over B traded shares. The lagged premiums are found to have certain predictive power over the future returns and volatility of both A and B shares, with some interesting patterns. Specifically, an increase in the premium ratio of A shares will be followed by a rise in the return of A shares and a fall in the return of B shares. It is found that both of the investors in Chinese A- and B-share markets reveal positive feedback trading behavior. Moreover, the liquidity and information availability will affect the magnitude of such behavior especially in B-share markets. By using multivariate GARCH model, it is also demonstrated that the unexpected changes in the premium ratio of A-share price over B-share price contribute to the return volatility of both A shares and B shares. These patterns may provide foundations for the development of pricing models for equity shares under market segmentation.     

The Information Environment of China''s A and B Shares: Can We Make Sense of the Numbers?

In 1990, three stock exchanges were opened in Shanghai, Shenzhen and Beijing. Partial privatization of China's enterprises began with offering two types of shares: A shares are sold only domestically to locals and are denominated in local currency; B shares are denominated in dollars and are sold only to foreign investors. All listed firms offer A shares, but to qualify for offering B shares, the firm must prepare financial statements in accordance with International Accounting Standards and also meet other requirements. Firms issuing A shares only adopt domestic accounting regulations.As a way of generating capital funds, market segmentation has been a success. Both types of shares, however, have two different information environments. The environment of A shares appears to be dominated by local regulations and customs at the time of offering or trading. The information environment of A shares appears to be relatively unstructured and is affected by informal communication between various groups. Other than the roles played by state officials and appointed managers, external monitoring of A shares appears to be limited. Independence and social acceptance of auditing appear to be making slow progress, especially when the majority of domestic CPA firms are government owned. In contrast, the information environment for the B shares is more structured because (1) financial reporting adheres to International Accounting Standards, (2) financial statements are audited by CPA firms with international practice; and (3) foreign investors — mainly large financial institutions — also act as external monitors.We elaborate on the differences between these two information environments and suggest that accounting earnings and A share prices are not correlated, but earnings and share prices are correlated for B shares. In an event-study approach, we find results inconsistent with both hypotheses — for 1994 and 1995 we find that earnings and unexpected returns are correlated for A shares but not for B shares. The high price volatility, the significant and continuing dominance of government officials, and the thinness of trade in B shares are offered as possible explanation for these results.     

Corporate governance and market segmentation: evidence from the price difference between Chinese A and H shares

This paper empirically examines whether the price difference between Chinese A shares, which are traded in the domestic market, and their matching H shares, which are traded in the Hong Kong market, can be explained by firms’ corporate governance characteristics. We find that the A- to H-share price premiums are higher for firms in which the controlling shareholders and corporate insiders have greater potential to expropriate wealth from outside investors. This result is robust when we use a variety of corporate governance variables specific to listed Chinese companies to explain the A-share price premiums and when we control for differences between domestic and foreign investors in required returns, degree of speculative trading, liquidity, information, and demand elasticity. Our findings highlight the important role of corporate governance in explaining the price difference in segmented stock markets.     

Foreign equity investment restrictions, capital flight, and shareholder wealth maximization: theory and evidence

This article provides a theory of foreign equity investmentrestrictions. We consider a model where the demand functionfor domestic shares differs between domestic and foreign investorsbecause of deadweight costs in holding domestic and foreignsecurities that depend on the country of residence of investors.We show that domestic entrepreneurs maximize firm value by discriminatingbetween domestic and foreign investors. The model implies thatcountries benefiting from capital flight have binding ownershiprestrictions such that foreign investors pay a higher pricefor shares than domestic investors. The empirical implicationsof this theory are supported by evidence from Switzerland.     

Information,sophistication, and foreign versus domestic investors’ performance

Using an intraday transaction dataset with trader identity, we study foreign and domestic investors’ trading activities and investment performance ahead of open-ending events of Taiwanese closed-end funds. Simply buying the funds at a discount and holding until open-ending generates large abnormal returns. All information required to execute this strategy is made public, so the events set up natural experiments to examine how investors trade, holding constant access to information. Foreign investors are net buyers ahead of the open-endings, more than doubling their positions and earning large abnormal returns. Domestic investors are net sellers while the discounts are still large, and forego large abnormal returns. The results suggest that investor sophistication in interpreting the same information is potentially an important determinant of investment performance differences across foreign and domestic investors.     

ADR holdings of US-based emerging market funds

What motivates investors to hold American Depositary Receipts (ADRs) rather than the underlying stock of US listed foreign firms? We analyze the investment allocation decision of actively-managed emerging market mutual fund managers. Although legal provisions are typically assumed to affect ADR and its underlying domestic shares equally, investors holding ADRs may have a higher level of legal protection as these securities are issued and traded in the US. We find that ADRs are the preferred mode of holdings if the local market of the issuer has weak investor protection, low liquidity and high transaction costs.     

Foreign institutional investors,information asymmetries,and asset valuation in emerging markets

This study investigates the effects of information asymmetries and asset valuation model differences (investor heterogeneity) between foreign and domestic investors on their distinct portfolio holdings in an emerging market setting. I argue that information asymmetry and investor heterogeneity views significantly interact in explaining the different asset allocation decisions of foreign and domestic investors. Employing a large dataset from Turkey, the findings suggest that both information asymmetry and investor heterogeneity view play a key role in explaining the investment decisions of different investor groups. Specifically, different from domestic investors, foreign investors are more likely to invest in firms with a higher global market performance which supports the investor heterogeneity view. However, this relationship only holds for firms with high information asymmetries. The difference in valuation models between foreign and domestic investors converge when asymmetric information problems between these investor groups weaken. This study contributes to the international finance literature by providing a new explanation of why foreign and domestic investors invest in different assets.     

Home country bias: Does domestic experience help investors enter foreign markets?

This paper investigates the dynamics of individuals’ investments leading up to their decision to make the first investment abroad. We show that investors first invest in domestic securities and only some time later they invest abroad in foreign securities. We also show that investors who trade more often in the domestic market start to invest abroad earlier. Our findings suggest that the experience investors acquire while they trade in the domestic market is a key reason why active investors enter the foreign market earlier. A reason is that highly educated investors as well as investors with more financial knowledge, arguably those for whom learning by trading is the least important, do not need to trade as much in the domestic market before they start investing in foreign securities. Another reason is that investors who start investing in foreign securities are able to improve on their performance afterwards. This improvement in performance constitutes further evidence that the home country bias is costly.     

THE BROKERAGE FIRM EFFECT IN HERDING: EVIDENCE FROM INDONESIA

We examine herding behavior of domestic and foreign investors in the Indonesian stock market. We document that both domestic and foreign investors from a particular brokerage firm tend to herd. The foreign investors exhibit a greater propensity to herd than domestic investors. However, when examining investor trading across brokerage firms, we find only weak evidence of herding by domestic investors and no herding by foreign investors. Our overall findings suggest a strong brokerage firm effect on herding but a weak marketwide effect. Moreover, we find evidence that the strong brokerage effect on herding is likely driven by acting on common information.     

Does the difference in valuation between domestic and foreign investors help explain their distinct holdings of domestic stocks?

This paper proposes an investor heterogeneity approach to the different domestic stock holdings between domestic and foreign investors. Specifically, we hypothesize that domestic and foreign investors evaluate domestic stocks via different models and thus arrive at different valuations for them; consequently, the two investor groups are attracted to different sets of domestic stocks. Using panel data from Korea, we find strong support for our hypothesis. More precisely, we find that the foreign ownership of a stock increases with foreigners’ valuation for the stock in excess of that of domestic investors. As we control for various firm characteristics known to be correlated with foreign ownership, our results indicate that the valuation difference between domestic and foreign investors can help explain the allocation of domestic stocks between the two groups over and above the existing explanations.     

A corporate governance explanation of the A-B share discount in China

B-shares listed in China are traded at substantial discounts to their corresponding A-shares although they have identical rights. We offer a governance explanation and suggest that relative to domestic investors, foreign investors care more about a firm’s governance quality. Results are supportive, as the B-share price discount is higher for firms that have weaker governance characterized by 1) higher ownership concentration, 2) ineffective boards with a higher proportion of directors appointed by the parent company, 3) lower dividend payouts, and 4) higher levels of information asymmetry.     

Immigration and equity home bias

Why do investors hold such large positions in domestic equity when there are gains to be made from international diversification? This equity home bias puzzle has received considerable attention in the literature, with asymmetric information on domestic and foreign assets (whether by individual choice or by market imperfection) emerging as the most plausible explanation. What happens when we consider a subset of investors whose information sets are closer to investors in foreign countries? I assess the relationship between immigration and equity home bias and find that inward migration is positively correlated with increased foreign equity positions and reduced home bias. Looking across income groups, outward migration reduces home bias for relatively rich countries, but may actually increase home bias when migration occurs to or from a developing country. These results suggest that immigration generates a positive externality of increased information flows for developed countries, but not for developing nations. The effects of immigration on investment are strongest within the Euro-Zone, suggesting that this positive externality of immigration is largest when barriers to portfolio diversification (such as currency risk) are lowest.     

International Portfolio Investment Flows

This article develops a model of international equity portfolio investment flows based on differences in informational endowments between foreign and domestic investors. It is shown that when domestic investors possess a cumulative information advantage over foreign investors about their domestic market, investors tend to purchase foreign assets in periods when the return on foreign assets is high and to sell when the return is low. The implications of the model are tested using data on United States (U.S.) equity portfolio flows.     

Investor type trading behavior and trade performance: Evidence from the Thai stock market

This paper examines the trading behavior and decomposes the trading performance of foreign, individual and institutional investors as well as proprietary traders in a dynamic emerging stock market, the Stock Exchange of Thailand. Foreign investors follow a positive feedback, momentum strategy and are good short term market timers but have poor security selection performance in poor markets, thus suggesting that they have a macro (market timing) but not a micro (security selection) informational advantage relative to local investors. Institutions and proprietary traders have poor security selection trading performance. Individuals display herding behavior and have fairly good security selection performance, but individual investors appear to compensate proprietary traders for the provision of short term liquidity by proprietary traders, so individuals' security selection gains are canceled out by market timing losses.     

Does foreign investor demand for information affect forecast accuracy? Evidence from the Chinese stock markets

Prior international accounting studies have examined mainly the supply side of analyst research. Specific trading rights and financial reporting systems in China provide a unique opportunity to test both demand and supply factors of analyst information. For shares traded only by less-informed foreign investors, the increased information demand may create incentives for analysts to exert greater efforts than for shares traded by local investors. This study provides evidence that analyst effort (proxied by analyst coverage) and expertise (proxied by consensus cross-analyst forecast variability) affect forecast accuracy more significantly for shares traded by foreign investors than for shares traded by local investors. Additionally, I find that the relation between analyst characteristics and relative forecast accuracy is stronger for shares traded by the foreign investors. The findings are consistent with analysts responding to demands for information by less-informed investors.     

International transmission of information: evidence from the Euroyen and Eurodollar futures markets

This paper examines the information transmission between Japan and the US by using the Tokyo Euroyen and Chicago Eurodollar futures. These two interest rate futures markets provide a better understanding of international information transmission than stock markets, which have been shown to exhibit nonsynchronous trading and market segmentation. The results show that traders in Tokyo (Chicago) use information that is revealed overnight in Chicago (Tokyo). The bivariate EGARCH-t model provides no evidence of volatility spillovers in either direction, suggesting that the opening price rapidly reflects foreign information. The overall results support the hypothesis that the domestic market efficiently adjusts to foreign news. The results are also broadly consistent with the covered interest arbitrage effects.     

IPO auctions and private information

IPO auctions, which provide an impartial way of determining IPO pricing and share allocations, offer a natural setting for examining whether institutional investors possess private information, and for measuring how valuable their information is. Analyzing detailed bidding data from Taiwan’s discriminatory (pay-as-bid) auctions, we find that, relative to retail investors, institutional investors tend to bid higher in auctions when IPO shares are more valuable, and that underpricing is larger in auctions with relatively higher institutional bids. These results imply that institutional investors are better informed about IPO value, and that they obtain higher information rents when they bid higher relative to retail investors. We estimate the value of institutional investors’ private information to be worth about 8.68% of return, which is the extra rate of return they command on their informational advantages over retail investors.     

Investor sentiment and feedback trading: Evidence from the exchange-traded fund markets

This paper extends the standard feedback trading model of Sentana and Wadhwani (1992) by allowing the demand for shares by feedback traders to depend on sentiment. Our empirical analysis of three largest Exchange-Traded Fund (ETF) contracts in the U.S. suggests that there is a significant positive feedback trading in these markets and the intensity of which is generally linked to investor sentiment. Specifically, the level of feedback trading tends to increase when investors are optimistic. In addition, we find that the influence of sentiment on feedback trading varies across market regimes. These results are consistent with the view that feedback trading activity is largely caused by the presence of sentiment-driven noise trading. Overall, the findings are important in understanding the role of sentiment in investment behaviour and market dynamics and are of direct relevance to the regulators and investors in ETF markets.