AH Premium: A Natural Experiment

Abstract

A large portion of the Chinese twin stocks is traded both in the Shanghai (A-share) and Hong-Kong (H-share) markets. The A- and H-shares are different assets since they can not be exchanged one-to-one. A-shares have sold at a premium: the AH premium. This premium is large (20-50%) and persistent, it has been present since the two markets were connected in Nov 2014 until now. Since both shares pay the same dividends and traders can operate on both markets this provides a natural experiment to test asset pricing models. We show that various standard RE and Bayesian RE asset pricing models cannot explain the AH premium, but a model of internally rational learning where agents learn about stock prices provides a natural explanation. This emphasizes the importance of modeling investors who learn about equity prices. The premium survives the introduction of convergence traders: those who bet on the AH premium going to zero are highly likely to suffer big losses.

Keywords: AH Premium, Learning about Prices, Convergence Trading

JEL Classification: G12, G15