This study investigates the impact of market segmentation on the valuation, volatility and liquidity of Chinese stocks. Listed companies in Mainland China can issue two different classes of stocks, with local A-shares restricted to domestic investors while foreign B- and H-shares restricted to foreign investors. The restriction imposed in China is very unique, as the market available to domestic and foreign investors are completely segmented from one another. Unlike other markets, domestic A-shares are sold at a premium relative to foreign B- and H-shares. We conjecture that the A-share price premium is determined by the limited alternative investment opportunities available to retail investors in China. We find that cross-sectional variation in the premiums for A-shares is negatively...[ Read more ]

This study investigates the impact of market segmentation on the valuation, volatility and liquidity of Chinese stocks. Listed companies in Mainland China can issue two different classes of stocks, with local A-shares restricted to domestic investors while foreign B- and H-shares restricted to foreign investors. The restriction imposed in China is very unique, as the market available to domestic and foreign investors are completely segmented from one another. Unlike other markets, domestic A-shares are sold at a premium relative to foreign B- and H-shares. We conjecture that the A-share price premium is determined by the limited alternative investment opportunities available to retail investors in China. We find that cross-sectional variation in the premiums for A-shares is negatively related to the relative supply of A-shares, and positively related to the relative supply of foreign shares. There is also evidence that the premiums can be explained by the speculative nature of retail investors, liquidity risk and firm size. Another important motivation for this study arises from the increasing numbers of companies has their shares cross-listed abroad to broaden their shareholder base and raise capital. Chinese listed companies raise foreign capital through issuing domestically listed B-shares, overseas listed H-shares in Hong Kong and ADRs in the US. Though companies view cross-listings as value enhancing, the change in liquidity and volatility, and the cost of trading following cross-listing may adversely affect the quality of the domestic equity market. Our study uncovers the following findings. First, cross-listings negatively affect stock liquidity as revealed with increased sensitivity of price volatility to volume. Second, only A-shares experience decline in volatility unrelated to volume after cross-listings of foreign shares and ADRs. Overall, our results suggest that the benefits and costs of cross-listing are not uniformly spread over all classes of investors in the same company.