Foreign Investment, Market Segmentation and Volatility in the Emerging Chinese Stock Market

Abstract

It is generally believed that in emerging markets, stock prices frequently deviate from their fundamental values resulting in high volatility caused, in part, by the growing influence of highly mobile foreign capital. This paper investigates volatility of Chinese B shares which are exclusively available to foreign investors. Findings suggest that despite possible segmentation, B shares do not show significantly different volatility characteristics when compared to the volatility characteristics of A shares which are available only to the domestic investors. Daily returns exhibit significant conditional volatility and non-linearity. Inclusion of dummy variable to reflect high volatility caused by a number of regulatory changes does not significantly change persistent volatility and non-linear characteristics. Also, we do not find presence of commonly reported day of the week effects for both Shanghai and Shenzhen A and B markets. Results suggest that with the sole exception of Shanghai B market, conditional volatility does not appear to influence the pricing of shares. Though correlation analysis suggests that B share markets are becoming progressively more correlated with the global markets; volatility in B shares appears to be more affected by the developments in the domestic A share markets.

Keywords: Emerging Chinese markets, Market segmentation, Conditional variance, Non-linearity, Economic liberlisation