PACIFIC-BASIN

FINANCE
JOURNAL
ELSEVIER

Pacific-Basin

Finance

Journal

( 1994)

243-260

isk and return on Chinas new stock markets:

Some preliminary evidence
Warren

Bailey*

Johnson Graduate School of Management, Cornell Unicersity, Ithaca, NY 14853-4201,

USA

Abstract

This paper looks at the brief history of Chinese stock markets since they opened to
the world with the listing of B shares targeted at non-Chinese investors. B share
returns exhibit little or no correlation with international stock index returns or
returns on China-related stocks traded in Hong Kong and the United States.
However, instruments for international risk premiums have some power to forecast B
share returns. Discounts at which B shares trade relative to A shares available to
Chinese citizens are correlated across firms and related to similar premiums in other
Asian markets. However, they exhibit little association with instruments for internat!onal risk premiums. The results suggest that B shares have considerable diversification value but are not entiytly segmented from global financial conditions.
Key words: China; International
JEL clu.ss$kution:

finance; Portfolio management; Emerging markets

F36, G 12, G 15, P33

1. Introduction

Chinas recent history of economic expansion is unique among developing

countries. Since Deng Xiaopings economic reforms began in 1978, Chinese
GDP growth has averaged 9::~ annually. The success of the Chinese
governments economic policies represents an interesting model for other
countries and has attracted the attention of direct and portfolio investors
from overseas.
The pace of change in Chinas capital market has been especially

*Tel.
Khoo.

(607) 2554627.
and participants

I thank

Jane Wu for research assistance, and Yuk

in the Fifth

Annual

PACAP

Conference

draft.

09~7-.C3~X,O4,~$07.0(~ (
SSDI 0927-038X(

I993 I:lscvictr Science B.V. Al1 rights wwrvcd

94)(HwwP

Shee Ghan,

for comments

Terence

on an earlier

244

W. Bailey /i Pat@- Basin Finance Journal 2 (1994)

243-260

significant in the last few years. The first corporate securities of post-1949
China were an issue of bond-like shares by Foshan Trust and Investment in
1984. Other such issues followed and, in 1986, interbank, currency, and bond
markets emerged in Shanghai and Shenyang. An August 1986 news story in
the authoritative Peoples Daily indicated that the issuance of corporate
shares was consistent with the Marxist ideal of common ownership of
capital. The following month, the Shanghai Stock Exchange was opened and
commenced trading bond-like shares of two socialist joint-stock companies.
Succeeding years saw additional issues of shares, the continued growth of the
Shanghai exchange, and the inauguration of the Shenzhen Stock Exchange in
the Special Economic Zone just north of Hong Kong.
Chinas equity markets opened to the outside world when trading in Class
B shares of Shanghai Vacuum Electron commenced on 21st February 1992.
Class B shares can be owned only by foreigners and trade alongside
otherwise identical Class A shares which can be owned only by Chinese
citizens. The Shanghai Vacuum issue was quickly followed by the listing of
Class B shares of China Southern Glass on the Shenzhen Stock Exchange on
28th February. Since that time, many additional B share listings have
appeared on the two bourses while many others are planned. The Stock
Exchange of Hong Kong lists China-related stocks like CITIC Pacific, China
Travel International, Denway, Guangdong investments, Tian An China
Land, and other so-called red chips. The first Chinese stock to list overseas,
Brilliance China Automotive Holdings, began trading on the New York
Stock Exchange on 9th October 1992. It has since been joined by three other
firms. Several other Chinese enterprises, including the well-known Tsingtao
Brewery, listed H shares on the Stock Exchange of Hong Kong in 1993.
This paper offers preliminary evidence on price behavior in Chinas new
stock markets. It addresses the enormous interest Chinas growing capital
markets have generated among academics, investors, development economists, and policy-makers. Furthermore, Chinese markets offer an opportunity to stud:? the behavior of a rapidly-growing emerging securities market
which accommodates foreign investors with a specific class of security. The
paper summarizes the univariate behavior of B share returns and their
associations with international stock index returns and other global economic indicators. The paper also examines the divergence between B share
prices and prices for the A shares available only to Chinese citizens, a
phenomenon which parallels other Asian and European stock markets. The
paper is organized as follows. Section 2 discusses the dataset and the
methodology employed. Section _,
1 piesents evidence on B share returns while
Section 4 presents evidence on the discounts at which B shares trade relative
to A shares. Section 5 is a summary and conclusion.

W. Bailey / Pac$c- Bash Finance Joumal2

(1994)

243-260

245

2. Data and methodology

Both the Shanghai and Shenzhen markets are modern exchanges based on
computerized order entry and book entry of ownership records. Capitalization of each market is on the order of several billion U.S. dollars.2 Figs. 1
and 2 plot weekly stock indices and trading volumes from the two exchanges.
It is apparent that prices have been quite volatile and volume has tended to
grow with time. The Shanghai market was subject to daily price change
limits of 1% through 5th May 1992 and 5yi through 20th May 1992.
The markets have opened to foreign investors only recently so a limited
time-series and cross-section of price data is available.3 Aside from some
sharp prices obtained from newspapers for the early part of our sample, all
data was obtained from the Bridge Information System. Closing B share
prices were gathered weekly (Fridays) for the period March 1992 to March
1993. To obtain the longest time-series possible, only those companies which
have traded for a relatively long time have been included in the sample.
From the Shanghai market, we selected China Textile Machinery and
Shanghai Vacuum Electron. From the Shenzhen market, we selected China
Southern Glass, China Bicycle Holdings, Huafa Electronics, Konka Electronics, Shenzhen Petrochemicals, and Shenzhen Property and Resources Development. Prices for A shares, or B share discounts expressed as a fraction of
the A share price, were also collected for each firm. To convert prices and
returns into Hong Kong currency, we also collected Renminbi/Hong Kong
dollar exchange rates quoted in the swap market for securities-related
currency transactions. These rates differ considerably from the official
exchange rate. Since B shares listed in Shanghai trade in U.S. dollars,4 it
was also necessary to obtain a Hong Kong dollar/U.S. dollar exchange rate
series.
Additional variables from international capital markets were collected as
follows. First, we obtained stock indexes representing Hong Kong (Hang
Seng), the U.S. (Standard and Poors 500), and the rest of Europe and Asia
(Europe, Australia, Far East Index), and share prices for Hong Kong
companies which have extensive business links to China: Guangdong Investments, Hopewell Holdings, Kong Wah Holdings, Luks Industrial, and Tian
An China Land. Kong Wah and Luks are particularly interesting as they are
the Hong Kong parents of Shenzhen-listed Konka and Huafa respectively.
Next, we constructed time-series of variables inspned by previous works on
In early 1993, the aggregate capitalization

of the two Chinese markets was $14 billion, with B

shares accounting for $1 billion of that amount. See Glnhal Finmce,
February 1993, p. 45.
A shares have traded prior to 1992 but data availability is even poorer.
4 Recently, B share quotes from Shenzhen have been supplied in U.S. dollars as well.
Because the sample is weekly, it was not possible to incorporate monthly Chinese macroeconomic factors into the analysis.

246

1,600

1,400
1,200
1,000
2
z

800

600

920608

920803

920928

Fig. 1. Shanghai

9!0&8

920803

930118

930315

Stock Exchange weekly activity.

920928

big. 2. Shcn/cn

921123

921123

930118

930315

Stock F.xchangc ueekl!~ activity.

time-varying risk premiums and the forecastibility of asset returns. They are
the yield on a three-month
U.S. Treasury bill (TBILL), the yield spread
between the benchmark thirty-year U.S. Treasury bond and the three-month
U.S. Treasury bill (TERM), the dividend yield on the Standard and Poors
500 index (SPDIV), and the lagged return on the Hang Seng Index
(RHANG-I). Additionally, we obtained share prices for several companies in
Thailand and Singapore which have both local-restricted and foreign classes
of shares similar to the Chinese case. Specifically, we obtained Main and
Alien Board prices from the Securities Exchange of Thailand for Bangkok
Bank and Siam Cement, and ordinary and foreign prices from the Stock
Exchange of Singapore for Development Bank of Singapore and Singapore
Airlines.
An additional
dataset consists of daily observations
of the price of
Brilliance China Automotive Holdings on the New York Stock Exchange
and JinBei Automotive Works A on the Shanghai exchange. These companies are related in that they share ownership of the same asset, a minibus
factory called Shenyang Automotive. They are of particular interest since
Brilliance China is the first PRC listing outside China. Since Brilliance China
began trading only in October 1992, the available data series is extremely
limited.
Most of the results in the paper are based on straightforward
summary
statistics and correlations which characterize the behavior of B share returns
and price discounts. Additionally, we adopt a time-series regression specification inspired by interesting recent work in empirical asset pricing. We follow
Keim and Stambaugh ( 1986), Fan-Is a11d French ( 1989), Ferson and Harvey
( 199 1), Campbell
and Hamao ( 1992), and other authors and relate B share
returns to lags of instrumental variables:

where ri(f,t + 1) represents the return on the jth B share from time t to t+ 1,
Z,(r) is the value of the ith ex ante variable observed at time t, and the sci
terms are coefficients. The idea behind the regression is that investors form
expectations of stock returns from observable information and impound
these in ex ante expected stock returns, E,{rj(t,r+ 1)). The &(t) variables are
a subset of the information, Q(t), available to investors when such expectations are formed:

where the i,i coefhcients are ex ante risk premiums and the /$ coefficients
represent the exposure of the stocks return to macroeconomic and fmancial
risks. Thus, the power of these variables to forecast realized stock returns is
consistent with the presence of time-varying risk remiums that are reflected,

248

W. Bailey / Pacific-Basin Finance Journal 2 ( 1994) 243-260

with noise, in realized returns. In particular, Ferson and Harvey (1993) and
other recent works show that common global financial variables can often
forecast stock index returns across many countries
Finally, we follow Bailey and Jagtiani (1993) in trying to explain the
discount offered for B shares relative to A shares, ( pjBb(t)- @(t))/( P*(t)).
Global factors should influence the prices that international investors are
willing to pay for B shares, relative to the A share prices paid by Chinese
citizens. For example, an increase in global interest rates can decrease the
prices that foreign investors are willing to pay for B shares relative to the
prices at which A shares trade, and, thus, increase the B share discount.
Proxies for the relevant global factors may be able to explain variation in B
share discounts. Furthermore, these common global factors should cause B
share discounts to rise and fall together, along with similar foreign price
premiums in other Asian markets.

3. Results: B share returns

Table 1 presents evidence on the distribution of weekly returns. The
number of return observations in the one year sample ranges from 34 to 52.
Average returns vary from negative to positive across the companies in the
sample. Most notable are the differences in return volatility across the
Shanghai, Shenzhen, and foreign markets. For example, China Southern
Glass has a weekly return standard deviation of 9.07% and Shanghai
Vacuum has a standard deviation of 7.06%. These volatilities are similar to
those exhibited by small China-related Hong Kong stocks like Guangdong
Investments but are much larger than the volatilities of well-known Chinarelated stocks like Hopewell. There are no discernable patterns in return
autocorrelations, perhaps because the small time-series does not allow for
very precise estimates. The evidence suggests that the Shenzhen and Shanghai market; are relatively small, volatile, and information-poor. Table 2
summarizes weekly trading activity in Shanghai and Shenzhen. Particularly
in Shanghai, A share activity is often greater than B share activity, although
all shares typically exhibit at least a few thousand board lots of volume each
week.
Table 3 presents correlations between returns on Chinese stocks and price
changes of the Standard and Poors 500, Hang Seng, and EAFE indexes.
Only a few of the correlations are statistically significant. While this suggests
that Chinese stocks may be good diversification vehicles for foreign investors,
the size and significance of correlation estimates may rise when longer timeseries of observations are available for analysis. Table 4 presents correlations
between returns on Chinese stocks and returns on China-related stocks
traded in Hong Kong. As we might expect, t ere are several significant

0.0109
0.0056
- 0.0030
0.0033
- 0.0023
0.0120
0.0054
0.0018
-0.0004

51
48
44
49
43
48
52
52
52
52
52
52
52
52

China Southern Glass B

China Bicycle Holdings B
Huafa Electronics B
Konka Electronics B
Shenzhen Petrochemicals B
Shenzhen Property and
Resources Development B

Hang Seng Index

Standard and Poors 500 Index
Europe, Australia Far East Index

Guangdong Investments
Hopewell Holdings
Kong Wah Holdings
Luks Industrial
Tian An China Land

0.0079
0.0038
-0.0016
-0.0005
0.0027

-0.0009
-0.0061

34
52

China Textile Machinery B

Shanghai Vacuum Electron B

Mean

Number of
observations

Ret urn series

0.0737
0.0447
0.0374
0.0644
0.07 15

- 0.023
- 0.066
0.038
- 0.032
0.096

0.010
-0.167
0.111

0.0353
0.0131
0.0200

0.074
0.129
0.028
0.189
-0.116

0.114
-0 133
- 0.096

0.05 1

0.109
- 0.020
0.219
0.087
0.001

0.159
0.093
0.126
0.193
0.110
0.109

-0.066
- 0.072

- 0.027
-0.117

Autocorrelation
at lag:

0.1101

0.0907
0.1060
0.1049
0.1024
0.0970

0.0776
0.0746

Standard
deviation

-0.100
- 0.02 1
-0.136
-0.131
0.023

- 0.005
-0.127
0.004

0.175

0.202
0.089
0.06 1
- 0.002
-0.116

-0.177
- 0.036

0.127
-0.046
0.001
- 0.265*
- 0.024

-0.042
0.056
-0.093

0.129

0.202
0.211
0.015
0.183
0.035

0.055
-0.044

Table 1
Univariate summary statistics on weekly stock and index returns. The sample consists of individual stock prices from the
Shanghai, Shenzhen, and, Hong Kong exchanges, and stock indexes representing Hong Kong, the U.S., and the rest of the
world. Return series are grouped as Shanghai stocks, Shenzhen stocks, international indexes, and China-related Hong Kong
stocks. B shares can be owned only by non-Chinese. Time period is March 1992 to March 1993. All returns are in Hong Kong
dollars. t, *, and ** indicate correlation coefficient is significant at loo/ 5%, or l/&level, respectively

7,

250

Table 2
Average weekly trading volume in board lots of loo0
shares. This table characterizes trading activity on Chinas
two stock exchanges. The sample includes individual stock
prices from the Shanghai and Shenzhen exchanges. In the
table, stocks are grouped as Shanghai stocks or Shenzhen
stocks. B shares can be owned only by non-Chinese. Time
period is March 1992 to March 1993
Company

A shares

B shares

China Textile Machinery

Shanghai Vacuum Electron

3416
11950

ld56
1537

2432
2917
_70
_
2205
2034

17x5
3079
3548

2474

4066

China Southern Glass

China Bicycle Holdings
Huafa Electronics
Kon ka Electronics
Shenzhen Petrochemicals
Shenzhen Property and
Resources Development

1068

2172

Table 3
Correlations between weekly returns on Chinese stocks and international stock indexes. The sample includes individual stock prices from the
Shanghai and Shenzhen exchanges, and stock indexes representing Hong
Kong. the U.S.. and the rest of the world. In the table, stocks are
grouped as Shanghai stocks or Shenzhen stocks. B shares can be owned
only by non-Chinese. All returns are in Hong Kong dollars. Time
period is March 1992 to March 1993. t, *. and ** indicate correlation
coefficient is significant at lo,,. S,,, or I,, leve!, respectively
Return series

Correlation

with return on

SP500

Hang Seng

EAFE

China Textile Machinery B

Shanghai Vacuum B

0.002
0.172

0.336t
0.366**

0.008
0.046

China Southern Glass B

China Bicycle B
Huafa B
Konka B
Shenzhen Petrochemicals B
Shenzhen Property B

0.000
- 0.065
0.185
-0.1 I5
0. IO2
0.062

0.140
0.101
0.028
0.05 I
- 0.023
0.209

0.133
-002
- 0.005
0.127
0.085
0.1 16

correlations. For example. the correlations between two property companies,

opewell and Shenzhen Properties, and between property stock Tian An
China Land and industrial stock Shanghai Vacuum are about 25:, or more,
and statistically significant. On the other hand, there are many examples of
lation. In particular, there appears to be no strong correlation
e two pairs of
ong Kong parents
a
en subsidiaries,

Table 4
Correlations between weekly returns on Chinese stocks and China-related stocks trading on the
stock exchange of Hong Kong. This table compares returns on Shanghai and Shenzhen listed B
shares with returns on China-related stocks listed in Hong Kong. B shares can be owned only
by non-Chinese. The Hong Kong companies are as follows. Hopewell has electricity generation,
highway construction, and property development projects in Guangdong province. Guangdong
and Tian An are smaller recent listings with property in Guangdong and Fujian provinces.
Kong Wah is the Hong Kong parent of Shenzhen-listed Konka and Luks is the Hong Kong
parent of Shenzhen-listed Huafa. All returns are in Hong Kong dollars. Time period is March
1992 to March 1993. i. *, and ** indicate correlation coefficient is signiftcant at lo,,, 5,,. or l,,
level, respectively
Return series

Correiation
Guangdong

China Textile Machinery

Shanghai Vacuum B

0.243
0.070

China Southern Glass B

China Bicycle B
Huafa Electronics B
Konka Electronics B
Shenzhen Petrochemicals B
Shenzhen Property B

0.t 10
0.009
0.023
0.026
0.129
0.101

with returns on:

--.-__ __~_
Hopewell
Kong Wah Luks
0.224 --0.303*
0 .a_
5t_
0.194
-0.015
0.167
0.033
0.239t

0.143
0.22910.025
0.026
-0.061
0.039
- 0.073
0.044

0.166
0.17gt
0.170
- 0.005
0.036
- 0.077
-0.041
0.028

____..___-. ..__~_ ~~~ _~

Tian An
0.521$**
0.511**
0.294**
0.279*
0.141
0.210
0.121
0.242-f

Kong Wah/Konka
and Luks/Huafa.
This evidence is puzzling: foreign
investors have access to both the Hong Kong and B share markets and. thus,
we would expect stronger correlations due to common information events
and shifts in global capital market conditions.
Table 5 presents estimates of regression 1 which attempt to identify the
presence of risk premiums common to B share returns and international
capital markets. B share returns are regressed on lags of U.S. interest rate
and stock market factors and a lagged Hong Kong stock market factor.
TBILL-1 reflects the global time value of money while TERM-l
reflects
expectations about changes in those costs. SPDIV-1 reflects U.S. equity
market risk premiums and RHANG-1 represents Hong Kong equity market
premiums. Many empirical asset pricing papers have employed similar lagged
interest rate and stock index variables to forecast stock returns. The table
indicates many associations
in the B share market. For example, the
regression for China Southern Glass has an adjusted R2 of 7.S),, a
significantly positive slope coefficient on the dollar interest rate, and a
significantly negative slope coefficient on the U.S. stock market dividend
yield. Other significant associations are evident among four of the other
seven stocks. Thus, there is substantial evidence that global factors influence
ex ante risk premiums in the B share market.
For evidence on associations between offshore versus onshore Chinarilliance China, a
related investments, Fig. 3 plots the price be

W. Bailer / Pacific- Bash Fittame Journal 2 ( 1994) 243-260

252

Table 5
Forecasting weekly returns on Chinese stocks with international macroeconomic and financial
indicators. This table measures the ability of global variables to forecast weekly returns on
Chinese stocks. The sample includes individual stocks from the Shanghai and Shenzhen
exchanges. B shares can be owned only by non-Chinese. Weekly returns are regressed on lags of
the 3 month U.S. Treasury bill yield (TBILL-I), the spread between the long U.S. Treasury bond
yield and the 3 month Treasury bill yield (TERM-l ). the dividend yield on the Standard and
Poors 500 Index (SPDIV-I), and the return on the Hang Seng Index (RHANG-I). All returns

are in Hong Kong dollars. Time period is March 1992 to March 1993. T-statistics are adjusted
for heteroskedasticy and serial correlation with the method of Newey and West (1987)
Slope coefficient (t-statistic) on:

Return series
__

._-.

..

TBILL-1

TERM-1

SPDIV-I

~__

RHANG-I

R2

DW

China Textile
Machinery B
Shanghai Vacuum B

0.0763
(0.92)
0.1187
(20.80)

0.3205
(30.02)
0.2235
(20.52)

-0.8587
-- - 0.4565
(-30.811
(-20.53)
-0.5000
-0.1068
( - 20.59)
( -0.85)

0.179

20.42

0.047

20.50

China Southern Glass B

0.1625
(20.11)
0.1878
(20.16)
0.0832
(0.71)
0.2277
(20.34)
0.1190
(0.98)
0.1491
( X:9)

0.2355
(10.85)
0.1971
( 10.60)
0.1285
(0.70)
0.3511
( 20.42 )
0.1731
(10.13)
0.1291
(0.86)

-0-5647
( - 20.72)
-0.6918
( - 20.51)
- 0.2742
( -0.80)
- 0.8463

0.075

20.05

0.087

20.08

China Bicycle B
Huafa B
Konka B
Shenzhen
Petrochemicals B
Shenzhen Property B

30.10)
- 0.5355
( - 10.82)
- 0.3096
(-

(-

10.00)

0.18b2
(0.59)
0.0554
(0.13)
0.5878
(10.31)
- 0.232 1

-0.99)
- 0.3603
(-0.91 )
- 0.2240
( -0.59)

-0.019
0.136

20.00
10.78

-0.004

10.62

-0.005

10.85

New York listed company, and the dollar value of the A shares of JinBei
Automotive, a Shanghai company? As mentioned previously, these companies share ownership of a minibus factory in northeast China. The plot
suggests that the two price series are not strongly correlated? This is
consistent with the presence of significant barriers to capital and information
flows between the Chinese citizens who trade JinBei shares and the nonChinese who trade Brilliance China shares. Additional results (not reported)
indicate that A share returns are uncorrelated with returns on the Standard
and Poors 500, Hang Seng, and EAFE indexes and with returns on the
China-related Hong Kong stocks in the dataset. This again suggests that
Chinas domestic securities market is effectively segmented from the outside
world, although there is evidence of significant positive correlation between

There are no B shares available for JinBei.

For the period from October 1992 to March
returns expressed in dollars is -0.022 (0.826).

1993. the correlation

(p-value) between daily

253

30
ri
i:
n
$25
f
=5

CBA

-c JBEA

820
I!
z
z
-15

921009

921109

921208

930108

930208

930309

Fig. 3. Daily prices for Brilliance China and JinBei Automotive.

the A and B share returns of China Bicycle, Huafa, Shenzhen Petrochemical,

and Shenzhen Properties.
To summarize this section, we can characterize the B share markets as
volatile and demonstrating only small (but sometimes significant) links to
broader international influences. There also appear to be severe barriers
between the A share markets and the New York, Hong Kong, and B share
markets where foreigners trade Chinese equities.

4. Results: the B share price discount

One of the most interesting facets of Chinas new stock markets is the
ability to observe the difference in the prices Chinese and non-Chinese
investors pay for identical shares. B shares are available only to foreigners
and A shares only to Chinese, and there are no straightforward arbitrage
channels to drive prices together. Similar phenomena can be observed in
Southeast Asian markets and in a few smaller European markets.
Table 6 presents time-series averages for the discounts at which B shares
trade relative to A shares. 9 Figs. 4 and 5 plot the weekly discounts for the
a To some extent, PRC resident investors can purchase B shares using overseas businesses or
nominees.
9The number of observations of the B share premiums equals the number of return observations
noted in Table 1 plus one.

254
Table 6
Summary statistics on the weekly B share premium and cross-correlations between changes in B
share premiums and changes in related premiums in other Asian stockmarkets. This table
compares the relative prices of Chinese A and B shares to relative prices of free and local
restricted shares from Thailand and Singapore. B shares can be owned only by non-Chinese.
The premium on B shares is computed as the B share price minus the A share price, divided by
the A share price. The premium represents the differential value a foreign investor puts on the
security. Similar computations based on Alien versus Main Board prices from Bangkok and
ordinary versus foreign prices from Singapore are used for the Thai and Singaporean stocks.
Time period is March 1992 to March 1993. i, *. and ** indicate correlation coefficient is
significant at lo,,, SO,. or loo level. respectively
Company

Average
B share
Premium

Correlation (p-value) of
premium change with
premium change for:
Bangkok
Bank

Siam
Cement

Development
Band of
Singapore

Singapore
Airlines

China Textile Machinery

Shanghai Vacuum

- 0.6837
- 0.6473

(i&41
-0.014

0.057
0.005

-0.140
-0.195

- 0.374*
-0.104

China Southern Glass

China Bicycle
Huafd
Konka
Shenzhen Petrochemicals
Shenzhen Property

- 0.463 1
- 0.4460
- 0.4950
- 0.4045
-0.4718
- 0.404 1

--0.06 1
- 0.038
-0.201
- 0.06 1
-0.115
-0 . I5
__

0.332*
0.352*
0.165
0.122
o-394**
0.386**

-0.101
- 0.049
- 0.092
- 0.072
0.095
- 0.09 1

-0.311*
- 0.342*
- 0.409**
-0.179
-0.289-I
- 0.428**

0.149

_ 0.055
0.019

0.201
-0.164
- 0.040**

Bangkok Bank
Siam Cement
Development Bank of Singapore
Singapore Airlines

0.1908
0.1842
0.1485
0.3 158

firms in our sample. The discount (or premium) is computed as the B share
price minus the A share price, divided by the A share price. The B share
discounts are uniformly enormous. For example, the discount for Shanghai
Vacuum averages 64.71,; and that for China Bicycle Holdings averages 44.67;.
Discounts in the Chinese markets contrast strongly with pre;ivums observed
in Thailand and Singapore. lo Table 6, along with Fig. 6, describe the
discounts (or, in these cases, premiums) for similar foreign class shares in
other nations. In contrast to the heavy discounts in the Chinese markets,
other Asian shares sell at considerable premiums to foreigners. For example,
Bangkok Bank traded at an average premium of 19.1,,;on the Alien Board
of the Stock Exchange of Thailand, and Singapore Airlines Foreign traded at
The Thai and Singaporean cases differ from China in that the local price serves as a lower
bound on the foreign price: if enough foreigners sell shares a+1y the level of foreign ownership
drops below legal limits, foreign class shares revert to local class shares which can be bought by
either ICKitlS or foreigners.

255

9;10306 920501 920626 920821 921016 921211

Fig. 4. Shanghai

930205

B share price discount as fraction of A share price.

0
-0.1

-0.2

CBH

-. - HUA
--KKE
-

SPC
SZP

--em
SGL

.s

-07--_
920327

920522

920717

920911

921106

930101

930226

Fig. 0. Shenzhen B share price discount as fraction of A share price.

W. Bailey / Pat@- Bash Finance Jowlal

256

2 ( 1994) 243-240

0.6

--

BBL
- SC6

--DBS
- SIA

920306920501920626920821921016921211930205
Fig.
6.Thai and Singaporean foreign share premiums.

an average premium of 3 1.6?; on the Stock Exchange of Singapore. Similar

premiums prevail for other Thai, Singaporean, Malaysian, Philippine, and
Indonesian stocks.
Hietala ( 1989) Bailey and Jagtiani ( 19933, and Stulz and Wasserfallen
( 1993) show price prentiurns for shares available to foreignt;rs can be caused
by differing foreign versus local required returns or by supply and demand
factors. We can formulate a specific explanation for large B share discounts
as fol!ows. First, the cost of capital for Chinese citizens may be lower than
that for foreigners: the Shanghai and Shenzhen stock markets may represent
the only investment alternative to low-yielding bank deposits. Second, if B
share investors are primarily Hong Kong residents, they may perceive
Chinese poli,ical and economic risks as undiversifiable and, thus, discount B
share prices heavily for systematic risk. Thus, rational asset pricing concepts
combined with circumstances peculiar to China and Hong Kong may explain
the B share discounts. Differential liquidity and information availability may
also explain time-series and cross-sectional variation in B share discounts. 2
Alternatively, we could invoke investor sentiment notions following Lee,
Shleifer, and Thaler ( 1991) in their study of discounts and premiums on
closed end mutual fund shares. Indeed, stories in the financial press have
- It isestimated

that $300 billion are invested in savings accounts at state-controlled

substantially below the inflation rate.
I2 See Amihud and Mendeison ( 1986), Merton ( 1987). and Bailey and Jagtiani ( 1993).

yields

Table 7
Cross-correlations between changes in B share premiums. This table compares the relative prices
of Chinese A and B shares within and across the Shanghai and Shenzhen markets. B shares can
be owned only by non-Chinese. The premium on B shares is computed as the B share price
minus the A share price, divided by the A share price. The premium represents the d~erent~~~
value a foreign investor puts
the security. Time
riod is March 1992 to March 1993. k, *,
and +* indicate correlation co cient is si~ni~ca~t at 1V,, So,, or tO, ievel, res
.____
_~ Company
Correlation between premium changes with:

China Textile
Machinery
Shanghai Vacuum
China Southern
Glass
Cka Bicycle
H uafa
Konk ,i
Shenzhen
Petrochemicals

Shanghai China
China
Vacuum Southern Bicycle
Glass

Huah

Konka

Shenzhen
Petrochemicals

Shenzhen
Pi-opery

0.870**

0.697**

0.608**

0.548**

0.582**

0.248

0.458**

0.213

0.197

0.352*

0.267t

0.053

0.?28**

0.655**

0.710*

&73**

0.161
~-.
0.686**

0.499**

0.762**
0.50f**

0.646**
0.624**
0.589**

0 779*
0:439**
0.627**
0.813**

suggested that unseasoned or unduly optimistic Chinese investors may be the

source of high A share prices.
Tables 6 and 7 contain additional intriguing evidence on the B share
discounts. Discounts and premiums across China, Singapore, and Thailand
show some tendency to move together. For example, the correlation between
the changes in the discount on China Bicycle and changes in the premium on
Siam Cement is about a third: the Alien Board premium on Siam Cement
tends to rise at the same time that the B share discount on Shanghai
Vacuum declines. Furthermore, Table 7 shows that the discounts are strongly
correlated across stocks within each Chinese market, and across the Shanghai and Shenzhen markets. This suggests the presence of a common
influence, possibly international investors who simultaneously trade Southeast Asian and Chinese markets as international capital market conditions
change and their portfolios require rebalancing. Some significant negative
correlations in Table 6 are hard to explain, though they may be due to the
idiosyncratic behavior of the premium on Singapore Airlines as suggested by
Fig. 6. Again, we could invoke psychological explanations: common movements in discounts and premiums across Asian countries can be caused by
common shifts in international
investor sentiment towards Asia, or by shifts
in international sentiment from one Asian country to another.
A final piece of statistical evidence on the B share discounts results from
regressing the B share discounts on the lagged factors e ployed as explana-

tory variables in regression regression 1. This indicates whether discounts are

related to global interest rates and risk premiums. While we cannot draw
strong conclusions from our small sample, the results (not reported) indicate
little association between B share discounts and global financial market
indicators. 3 This suggests that Chinese asset prices are largely uncorrelated
with systematic global forces, although this is inconsistent with the observed
correlations between B share discounts and foreign class premiums in
Thailand and Singapore.

5. Summary and conclusion

This paper has presented ?entative evidence on the behavior of prices on

Chinas new stock markets. The focus has been on the B shares which are
available :G non-Chinese investors. B share returns have little association
with international stock index returns or returns on China-related stocks
traded in Hong Kong and New York. There are, however, significant
associations between B share returns and lagged values of global financial
market indicators, suggesting some commonalities between global and B
share required returns. Discounts on B shares relative to A shares are
inconsistent with premiums observed in other Asian capital markets and are
hard to explain quantitatively, though it is sensible to imagine that the pentup savings of Chinese citizens and the systematic political risk perceived by
Hong Kong investors have an effect. Furthermore, the correlation of B share
discounts with similar phenomena in Singapore and Thailand is consistent
with simple notions of equilibrium cross-border asset pricing.
Several methodological issues and other questions should be noted. We
have examined a very short series 3f weekly prices for a small cross-section
of securities. Furthermore, we have not imposed restrictions implied by
equilibrium asset pricing models, but have merely presented simple correlations and regressions inspired by those models. Thus, results which are
seemingly consistent with the predictions of equilibrium asset pricing theories
may merely represent spurious correlations driven by uztliers or other
artifacts of the data. Additionally, we have not addressed issues of market
efficiency which often arise in the financial and popular press. For
example. the dearth of information on listed companies and the lack of
corporate accountability for funds raised by securities issues raise questions
about the purposes these markets serve and the motivations of the corporations and investors who participate in them. *

inese market data grows,

evidence.

Differences

in the

it

price-

aracteristics of Chinese securities listed in China

versus Hong Kong and
bv York remain to be explained. 6 The data on
the great number of China-relate
ong stocks and close
funds can help expand the cross-section of securities available for study.
Rather than adopting t e international focus of this paper, it wil be useful to
focus on interactions between A share prices and domestic Chinese banking,
monetary, and macroeconomic conditions. When historical balance sheet and
income statement data becomes available, a wealth of additional research
becomes possible. Thus, this is likely to be only the first of many papers to
be written about Chinas growing capital markets.

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