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Capturing the Chinese A-shares and H-shares Anomaly


Introduction

The Chinese equity market is composed of a domestic and an offshore market. The Shanghai Stock Exchange and the Shenzhen Stock Exchange are the two exchanges operating in mainland China and they were established in the early 1990s. The majority of Chinese stocks are listed on the Shanghai or Shenzhen Stock Exchanges and these stocks are generally known as China A-shares. A-shares constitute China’s domestic market. In addition, there is an offshore market. Twenty five years ago the then China Vice Premier Zhu Rongji gave his approval for Chinese State Owned Enterprises (SOEs) to list their stocks on the Hong Kong Stock Exchange. The intention, in addition to capital raising, was to upgrade the SOEs’ corporate governance and management standards through fulfilling international practices. The offshore Chinese equity market has grown rapidly since. Nowadays it is easy to find Chinese companies listed on different exchanges globally including Hong Kong, New York, London or Singapore etc. In order to form a complete picture of the Chinese market both the domestic and offshore markets must be considered together.

When a PRC-incorporated company is listed on the Hong Kong Stock Exchange (HKEx), it is regarded as the H-share, with the letter H referring to Hong Kong. According to information provided by HKEx, nine state enterprises were approved for listing in Hong Kong on October 6, 1992. Tsingtao Brewery was the first company to be listed. Its shares started trading on the Hong Kong Stock Exchange on July 15, 1993. The second batch was announced on January 27, 1994 and altogether 22 companies, mainly from heavy industries such as energy, transport and raw materials were listed. The existence of A-share and H-share markets enables Chinese companies to choose their listing venue. Moreover, Chinese companies can also choose to list their stock on both the domestic and an offshore exchange simultaneously. The stock will then be dually-listed on both the A-share market and H-share market.

In an ideal environment, where capital flows are not restricted and information is symmetric, the A-share market and the H-share market should be integrated and a single price should prevail in both markets. Extensive research has gone into studying the relationship between A- and H-share prices. Cai, McGuinness and Zhang (2011) developed a non-linear Markov error correction approach to examine the co-integration relation between the H-shares and A-shares prices across the period from 1999 to 2009. Choi et al (2013) found consistent and significant co-integration among these A-shares and H-shares dual-listed stocks for the period 2004-2011. Li, Chui and Li (2014) demonstrated that co-integration and error-correction mechanism exist between the A-share and the H-share for the period from 2009-2013.

The behavior of the price differential between A-shares and H-shares of dual-listed companies will be studied in this article for the sample period from 2006-2017. In particular we investigate whether a share class selection mechanism applied to a universe of Chinese stocks can deliver improved index characteristics compared to a market-capitalization weighted China A-shares benchmark.

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