Speculative Trading and Stock Prices: An Analysis of Chinese A-B Share Premia

Abstract

China’s stock markets, with stringent short-sales constraints, dominance of inexperienced individual investors, a small asset float and heavy share turnover (500% per year despite a high transaction cost), provide a unique opportunity to study non-fundamental components in stock prices. In particular, several dozen Chinese firms offered two classes of shares: class A, which could only be held by domestic investors, and class B, which could only be traded by foreigners. Despite their identical rights, A-share prices were on average 420% higher than the corresponding B shares. By exploring several different model specifications, we find that the turnover rate of A shares is able to explain a large portion of the cross-sectional variation in A-B share premium. Our further analysis of the relationship between asset float and share turnover shows that trading in A-share markets is more likely to be driven by speculation than by liquidity factors. Our results are robust after controlling for the effects of liquidity, discount rates, and differential risk and demand curves by local and foreign investors.