Asset Pricing in China's Domestic Stock Markets: Is There a Logic?

53 Pages Posted: 6 Feb 2008

See all articles by Wei Huang

Wei Huang

University of Hawaii at Manoa - Shidler College of Business

Cheol S. Eun

Georgia Institute of Technology - Finance Area

Abstract

China's stock markets have grown rapidly since their inception and have become an increasingly important emerging market for international investors. However, there are few systematic studies on how asset prices are formed in Chinese domestic equity markets; popular financial media even depict the market as irrational. In this paper, we study the asset pricing mechanism in the nascent Chinese stock markets, with the objective of identifying variables that capture the cross-sectional variation in average stock returns. We focus on the effects of various market imperfections in China. We find that while the market risk (beta) is not priced, there is a significantly negative relationship between firm-specific risk and expected returns. Chinese investors are willing to pay a significant premium for more liquid stocks or for dividend-paying stocks. Furthermore, investors value local A-shares more if there are offshore counterparts (e.g., B- and H- shares) for foreigners, implying that a Chinese firm with a foreign shareholder base has a lower cost of capital, ceteris paribus. Lastly, as with U.S. and other mature markets, firm size and the book-to-market ratio are systematically related to stock returns. Given market imperfections, stocks are priced rather rationally in China, despite the widespread perception to the contrary.

Keywords: Chinese stock market, Emerging markets, Asset pricing, Cross-sectional stock returns

JEL Classification: G12, G15, G18

Suggested Citation

Huang, Wei and Eun, Cheol S., Asset Pricing in China's Domestic Stock Markets: Is There a Logic?. Pacific-Basin Finance Journal, Vol. 15, No. 5, 2007. Available at SSRN: https://ssrn.com/abstract=1088491

Wei Huang (Contact Author)

University of Hawaii at Manoa - Shidler College of Business ( email )

2404 Maile Way
Honolulu, HI 96822
United States
808-956-7679 (Phone)
808-956-9887 (Fax)

Cheol S. Eun

Georgia Institute of Technology - Finance Area ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

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