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Essays on Mispricing in the Chinese Stock Market 302 MO ZHANG ESSAYS ON MISPRICING IN THE CHINESE STOCK MARKET 302 EKONOMI OCH SAMHÄLLE Along with Chinese economic development, the Chi- efficient market theory. The second essay uses this phe- ECONOMICS AND SOCIETY nese stock market is growing rapidly, and is now the sec- nomenon as a natural experiment to test whether a new ond largest stock market in the world. However, despite reform policy, namely granting permission for short selling, its size, the Chinese stock market trades like the wildest benefits the efficiency of the Chinese stock market. When emerging markets, with huge volatility, big boom and bust the Chinese government lift the ban on short selling in the cycles, driven by fast-trading individual investors, and Chinese stock market, mispricing decreases significantly, heavy involvement from the government. Owing to the even though the volume of short selling in the Chinese stock peculiarity of the Chinese economic and political system, market is trivial relative to total trading volume. Instead of there are some unique structures within the Chinese stock studying a particular set of stocks, the third essay focuses market. In one sense, this makes the Chinese stock market on the mispricing formation mechanism at the general mar- an interesting laboratory. This dissertation comprises three ket level. The market results show that both the resale op- single-authored essays. The first two analyze a special tion and inflation illusion hypotheses can explain the level phenomenon, called B-share discounts in the Chinese stock of market mispricing. Only investors’ heterogeneous beliefs market, seeking to explain why this phenomenon exists affect the volatility of market mispricing, in line with the re- from the perspective of exchange risk. It shows that dual- sale option hypothesis prediction. Additionally, the results ON MISPRICING IN THE CHINESE STOCK MARKET MO ZHANG – ESSAYS class stock price disparity in the Chinese stock market can show that state-controlled industries tend to be underesti- be explained, in a way, by exchange risk, meaning that “to mated more, when mispricing is negative, but to be over- some extent, investors are rational and ask for compensa- valued less, when mispricing is positive. tion for taking extra risks”. This is in line with the classical ESSAYS ON MISPRICING IN THE CHINESE STOCK MARKET MO ZHANG HANKEN SCHOOL OF ECONOMICS HELSINKI ARKADIANKATU 22, P.O. BOX 479 00101 HELSINKI, FINLAND TEL +358 (0)9 431 331. FAX +358 (0)9 431 33 333 ISBN 978-952-232-315-6 (printed) VAASA ISBN 978-952-232-316-3 (PDF) KIRJASTONKATU 16, P.O. BOX 287 ISSN-L 0424-7256 65101 VAASA, FINLAND ISSN 0424-7256 (printed) TEL +358 (0)6 3533 700. FAX +358 (0)6 3533 703 ISSN 2242-699X (PDF) [email protected] JUVENES PRINT, HELSINKI HANKEN.FI/DHANKEN Ekonomi och samhälle Economics and Society Skrifter utgivna vid Svenska handelshögskolan Publications of the Hanken School of Economics No 302 Mo Zhang Essays on Mispricing in the Chinese Stock Market Helsinki 2016 Essays on Mispricing in the Chinese Stock Market Key words: Asset pricing, Mispricing, Chinese stock market, Behavioral finance, Heterogeneous beliefs © Hanken School of Economics & Mo Zhang, 2016 Mo Zhang Hanken School of Economics Department of Finance and Statistics P.O.Box 287, 65101 Vaasa, Finland Hanken School of Economics ISBN 978-952-232-315-6 (printed) ISBN 978-952-232-316-3 (PDF) ISSN-L 0424-7256 ISSN 0424-7256 (printed) ISSN 2242-699X (PDF) Juvenes Print – Suomen Yliopistopaino Oy, Tampere 2016 i PREFACE It is an unbelievable and amazing venture. I am extremely grateful to my supervisor, Professor Johan Knif for his support, knowledge and guidance. Thanks for taking me in and trusting me through the whole process. I would like to thank Professor Kenneth Högholm for his valuable advice and direction. I am indebted to Professor Timo Korkeamäki and Anders Löflund for their support when I worked in Helsinki campus. I would like to thank Professor Benjamin Maury for giving me the opportunity to assist in his courses. I enjoy the time to work with great fellow students and Professors at the Department, Abu Shaker, Agniezka Jach, David Gonzalez, Dennis Sundvik, Fredrik Huhtamäki, Gonul Colak, Hilal Butt, Jan Antell, Jesper Haga, John Petterson, Magnus Blomkvist, Nasib Nabulsi, Paulo Maio, Peng Wang, Peter Nyberg, Salla Pöyry, Sergey Osmekhin, Syed Mujahid Hussain, Yamin Xie, Zhamilya Assilbekova and many others. I would like to thank the external examiners, Professor George Athanassakos and Professor Seppo Pynnönen. Their valuable comments help me improve this dissertation greatly. I am very grateful with the department of finance and statistics in Hanken, the Hanken Foundation and the WCEFIR fund for providing financial support during my PhD study. I want to thank Mikko Leppämäki, the graduate School of Finance (GSF), and the Nordic Finance Network (NFN) for the well-structured courses and good seminars. Thanks to my parents, Ping Zhang and Yi Cao, for putting faith in me and giving me unconditional love. Your love is one of the most precious gifts in my life. I am especially grateful to my boyfriend Yi Wang for standing with me and being through those ups and downs. Finally, thanks to myself for being me. August 1, 2016 Mo Zhang ii iii CONTENTS 1 INTRODUCTION....................................................................................... 1 1.1 Regime shifts in the Chinese stock market .......................................................... 2 1.1.1 Establishment and infancy period of the Chinese stock market ................. 2 1.1.2 Lift of market segmentation ......................................................................... 3 1.1.3 Split-share structure reform ......................................................................... 5 1.1.4 Life of short-selling ban ................................................................................ 5 1.2 Efficient market hypothesis vs. behavioral finance theory ................................. 6 1.2.1 Efficient market hypothesis .......................................................................... 6 1.2.2Behavioral finance theory ............................................................................. 7 2 SUMMARIES OF ESSAYS ...................................................................... 12 2.1 Understanding B-share discounts: Exchange risk in the Chinese stock market ........................................................................................................ 12 2.2 Impact of short selling on B-share discounts in the Chinese stock market ...... 14 2.3 An analysis of Chinese stock market mispricing ................................................15 3 CONCLUDING REMARKS .................................................................... 16 THE ESSAYS 1. Zhang, M. (2013). Understanding B-share discounts: Exchange risk in the Chinese stock market. Manuscript, Hanken School of Economics. 2. Zhang, M. (2015). Impact of short selling on B-share discounts in the Chinese stock market. Manuscript, Hanken School of Economics. 3. Zhang, M. (2015). An analysis of Chinese stock market mispricing. Manuscript, Hanken School of Economics. iv Part I Background, Theory and Main Findings 1 INTRODUCTION Along with Chinese economic development, the Chinese stock market is growing rapidly, and is now the second largest stock market in the world.1 However, despite its size, the Chinese stock market trades like the wildest emerging markets, with huge volatility, big boom and bust cycles, driven by fast-trading individual investors, and heavy involvement from the government. The modern Chinese stock market is young by global standards, with trading resuming 25 years ago after being interrupted for decades by the Communist revolution (from 1950). Owing to the peculiarity of the Chinese economic and political system, there are some unique structures within the Chinese stock market. In one sense, this makes the Chinese stock market an interesting laboratory. This dissertation comprises three single-authored essays. The first two analyze a special phenomenon, called B-share discounts in the Chinese stock market, seeking to explain why this phenomenon exists from the perspective of exchange risk. The second essay uses this phenomenon as a natural experiment to test whether a new reform policy, namely granting permission for short selling, benefits the efficiency of the Chinese stock market. Instead of studying a particular set of stocks, the third essay focuses on the mispricing formation mechanism at the general market level. The Chinese stock market has carried out a series of reforms during the 2000s. As a result, the market structures and policies have changed a great deal, noticeably affecting market participants’ behaviors. Therefore, the next section describes the special features and regime shifts within the Chinese stock market. Then, the author examines the theoretical difference between efficient market hypothesis and behavioral finance. Of the two, the features of the Chinese stock market more closely satisfy the assumptions of behavioral financial theory and, thus, the author focuses more on this theory here. The concluding section discusses the main contents of all three essays, including the contributions and implications of their results. 1 The market capitalization of the Shanghai Stock Exchange and the Shenzhen Stock Exchange are counted together. Data source: Bloomberg. 1 1.1 Regime shifts in the Chinese stock market This section smmaries the evelopment path of the
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