The Effect of the China Connect

Abstract

We analyze the effects on Chinese firms of the "China Connect" equity market liberalization. Because China is a capital abundant country, unlike typical emerging markets in the literature, the benefits and costs of liberalization are logically different. Nonetheless, the liberalization brought benefits: lower funding costs, higher stock prices, and more investment for connected firms compared to unconnected firms, despite a common negative effect on all firms from capital outflows. These benefits come from a new channel: reducing domestic credit misallocation between private- and state-owned enterprises. We also document costs: connected firms became more sensitive to external shocks than unconnected firms.

Keywords: Capital Account Liberalization; Capital Controls; Global Financial Cycle; Foreign Spillovers; Equity Returns; Corporate Investment

JEL Classification: F38; E40; E52; G15