The effect of the liberalization of the Chinese stock market on returns

ABSTRACT

We examine the short-term effects of the liberalization of the Chinese stock market on returns. We find a positive and significant abnormal return associated with the announcement of the liberalization of the Shanghai Stock Exchange. Exploiting  features of the reform, we are able to compare stocks directly and indirectly affected by the liberalization. We find that all stock prices reflect this announcement premium equally, suggesting that the premium does not reflect an increase in expected liquidity. We further find that observed liquidity, as measured by volume and price impact, did not increase following the liberalization. We conclude that the observed premium reflects a diversification benefit for Chinese investors.

KEYWORDS:

• Financial liberalization
• stock market
• liquidity
• diversification
• China

JEL CLASSIFICATION:

• G18
• G15
• G14

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Aggregate quotas were subsequently abolished in August 2016.

² Note that an ADF test confirms that the dependent variable is stationary over the sample period.

³ Note that an ADF test confirms that the three control portfolio return series are stationary over the sample period.

⁴ The raw exchange rate series contains a unit root as confirmed by an ADF test. To ensure stationarity of the right-hand side variables, the exchange rate enters the specification as the daily residual from the Hodrick–Prescott filtered raw series estimated on a sample period of 241 days centred on the announcement date.

⁵ The three volume series each contain a unit root as confirmed by ADF tests. To ensure stationarity of the left-hand side variable, the trading volume series enter the specification as the daily residual from the Hodrick-Prescott filtered raw series estimated on a sample period of 241 days centred on the launch date.

⁶ To ensure stationarity, the exchange rate is measured as the daily residual from the Hodrick–Prescott filtered raw exchange rate series.

⁷ Interest rate cuts in the sample period occurred on the following dates: 21 November, 4 February 2014, 2015 and 1 March 2015.

⁸ The three volume regressions contain one lagged value of the dependent variable. The volume regressions also include one lagged value of the exchange rate series. The price impact regressions include one and eight lagged values of the dependent variable for the 1- and 3-day Amihud measures, respectively. Note that the 3-day Amihud measure exhibits substantially more autocorrelation because it is defined as a 3-day moving average.

⁹ Similar results are obtained if instead of robust SEs, time-varying volatilty is modelled explicitly using a GARCH(1,1) process.

¹⁰ Note that the coefficient estimates on the treatment variable for both the 1- and 3-day Amihud measures in Table 3 indicate that treated SSE stocks are in general more liquid, i.e. have lower price impact measures, than untreated SSE stocks (see columns (3) and (4)).