Journal of Multinational Financial Management 10 2000 421 – 438
Market segmentation and information diffusion in China’s stock markets
Boo Sjo¨o¨
a,b
, Jianhua Zhang
a,
a
Department of Economics, School of Economics and Commercial Law, Go¨teborg Uni6ersity, P.O. Box
640
, Vasagatan
1
,
405 30
Go¨teborg, Sweden
b
Department of Economic and Political Sciences, Uni6ersity College of Sko¨6de,
541 28
Sko¨6de, Sweden Received 15 July 1999; accepted 20 March 2000
Abstract
This study analyses the information diffusion between Chinese A shares restricted to domestic investors and B shares restricted to foreign investors. The results show that there
is an important long-run information diffusion between A and B shares. In the Shanghai stock market, information flows from foreign to domestic investors. However, in the smaller
and less liquid Shenzhen stock market, the information diffusion goes in the opposite way. The direction of the information diffusion is determined by the choice of stock exchange
rather than firm size. © 2000 Elsevier Science B.V. All rights reserved.
JEL classification
:
G12; G14 Keywords
:
Information flow; Information diffusion; A and B shares; Premium www.elsevier.comlocateeconbase
1. Introduction
Firms often issue different types of equity to discriminate between different investors. In China, firms are required to discriminate between domestic and
foreign investors to ensure that ownership remains under Chinese control. Domes- tic investors can only buy A shares and foreign investors can only buy B shares.
The shares are identical in terms of voting power and dividend claims. Due to the
Corresponding author. Tel.: + 46-31-7732689; fax: + 46-31-7731043. E-mail address
:
jianhua.zhangeconomics.gu.se J. Zhang. 1042-444X00 - see front matter © 2000 Elsevier Science B.V. All rights reserved.
PII: S 1 0 4 2 - 4 4 4 X 0 0 0 0 0 3 5 - 9
existing regulations, the amount of outstanding B shares is always smaller, so foreign investors are forced to be minority shareholders. The outcome is that the
equity of the same firm is traded at the same time, at the same exchange, but by two different investor groups and at quite different prices. Typically, A shares trade at
a premium over B shares. Moreover, the premium is not constant. It changes over time in a way that resembles an integrated stochastic process.
This study tests a number of aspects concerning the observed information diffusion between A and B shares in China’s emerging stock market ESM. The
objectives are to learn more about the role of foreign investors in ESMs and to investigate where price information is produced.
Several factors can cause information diffusion between domestic and foreign investors in emerging markets. First, the foreign investors in China are mainly big
financial institutions. Compared with the domestic investors, foreign institutional investors can in general be assumed to be more experienced, have better means of
obtaining information, and have access to more advanced technology to analyze data. Thus, the presence of foreign investors can be a buy signal for the relatively
uninformed domestic investors. In this situation, the prices of B shares would lead those of A shares reflecting that domestic investors get information from foreign
investors.
Second, the domestic investors might have the information advantage. They can be better in acquiring relevant news from local sources. In this case, the prices of
A shares would lead the prices of B shares, because of foreign investors learning from domestic investors. Third, it follows from the discussion that the price
information can flow in both directions. Different investor groups can have different comparative advantages in acquiring information. Finally, as an extreme
case, the markets for A and B shares might be completely segmented, showing no correlation and lead-lag relations what so ever. Foreign investors can face severe
political risk in emerging financial markets, and they might form quite different conditional expectations about the future prospects of the Chinese economy in
general and of the cash flow of the individual firms in particular.
Earlier studies on Chinese stock markets have focused on either the price premia, or on the lead-lag structure between the returns of A and B shares. Chui and Kwok
1998 investigate the cross-autocorrelation structure of A and B share returns in China. Their conclusion is that the returns on B shares lead the returns on A
shares. This result, however, is based on an implicit assumption of a complete long-run segmentation between A and B shares. There is no ground for making
such an assumption about the relationship between the prices of A and B shares. In fact, it is natural to assume that the difference between the price levels of A and B
shares contains information of coming returns. We test this hypothesis and investi- gate its consequences on the flow of information by modeling the prices as a
multivariate vector error correction process
1
.
1
Harris et al. 1995 discuss cointegration in stock transactions data. They focus on specification and estimation of an error correction mechanism for IBM price on different exchanges in order to investigate
the price-discovery theory.
Our results support the view in Chui and Kwok 1998, that information flows from foreign investors to domestic investors, but only for the Shanghai market. We
obtain this result for both the short and the long run. In the smaller Shenzhen market, the causality is more ambiguous. Here, foreign investors affect returns only
in the short run. In the long run, information flows from domestic to foreign investors. Our results suggest that the most important factor for whether informa-
tion flows from domestic or foreign investors is the choice of stock exchange rather than firm size.
The study is organized as follows. Section 2 discusses theories and hypotheses related to this study. Section 3 explains the use of cointegration and vector error
correction models for analyzing information diffusion. Section 4 presents the empirical results. Finally, Section 5 concludes the study.
2. Theoretical framework and hypotheses
