Market Segmentation and Foreign Share Discount in China

In this paper, I formulate and test a one-period capital asset pricing model under ownership restrictions to explain the price differentials between the classes of shares that can be bought by Chinese citizens and by foreign investors, respectively. I find that time-series variability in the spread between domestic and foreign share returns is consistent with differences in risk exposures and expected risk premium, thus supporting the hypothesis of effective market segmentation and price discrimination. I also find that cross-sectional differences between domestic and foreign share returns are correlated with individual shares'; market betas. The result further supports the price discrimination hypothesis.