The Valuation Differential between Class A and B Shares: Country Risk in the Chinese Stock Market

The Chinese stock market has been characterized by a strict segmentation between domestic and foreign investors, with listed companies issuing Class A shares to domestic, and Class B shares to foreign, investors, respectively. Entitled to the same rights and obligations, however, the two classes of shares are traded at significantly different prices. The valuation differential is attributable to the different sets of investment opportunities available to domestic versus foreign investors and their risk tolerance. Foreign investors would require a higher rate of return to adjust for the country‐specific risk related to the Chinese stock market. The country risk of China can be decomposed into political risk, exchange rate risk, interest rate risk and market risk. Empirical tests provide strong evidence to support the decomposition model, showing the political risk of China as an important component.