The Structural Changes of Liquidity Risk, and Liquidity Risk Premium in China Stock Market

ABSTRACT

The Chinese stock market’s liquidity risk premium at medium-size and large companies declined from 2002 to 2016. We find the liquidity risk premium is negative during this period. The negative liquidity risk premium demonstrates that sellers prefer to compensate buyers when stock prices crash. In addition, the portfolio liquidity risk has a structural change after the split-share structure reform. Portfolio liquidity risk diverges from the relevant prehistorical betas, during the split-share structure reform. Similarly, the historical liquidity beta is nonmonotonic with postranking liquidity beta, before the reform. However, the historical liquidity beta is monotonic with postranking beta, after the reform.

KEY WORDS:

• Chinese stock market
• liquidity risk premium
• split-share structure reform

JEL:

• D53
• G12
• P11

A special thanks to Minjoo Kim at University of Liverpool and Sai Ding at University of Glasgow for invaluable discussions, encouragement, and for insightful comments.

Notes

1. “A” share trade exclusively in Chinese currency, comprise about 95% of tradable shares, and it is only available to Chinese investors. The remaining 5% of tradable shares, called “B” shares, are traded in U.S. currency in Shanghai and traded in Hong Kong currency in Shenzhen. They are purchasable by both foreigners and Chinese investors who possess foreign currency.

2. The so-called Split share structure reform means implementing the reform to convert all nontradable shares into tradable shares. Generally, in order to protect minority shareholders during the process of reform, the nontradeable shareholders pay a certain price (liquidity premium or compensation term) to tradeable shareholders through negotiation mechanism). After both parties reach an agreement with the compensation terms, nontradable shares can become tradable, the majority nontradable shareholders obtain the liquidity right of shares by paid shares to tradeable shareholder.

3. According to analyses by Wind.

4. Over a year of ownership, the tax rate is 5%; ownership from 1 month to 1 year raises the tax rate to 10%; for only 1 month of ownership, the tax rate is 20%. Before January 2013, the actual tax rate on dividends was 10%.