Dissertation zur Erlangung des akademischen Grades eines Doktors der Wirtschaftswissenschaften der Julius-Maximilians-Universität Würzburg mit dem Thema Applicability of Intrinsic Value Models at the Segmented Chinese Stock Market vorgelegt von Diplom-Kaufmann Ole Gerdau aus Hamburg Würzburg, den 20. März 2011 Betreuer: Prof. Dr. Hansrudi Lenz Table of Contents I I. Table of Contents I. Table of Contents .......................................................................................................................... I II. Summary of Abbreviations .......................................................................................................... IV III. Summary of Symbols ................................................................................................................ VII IV. List of Figures ........................................................................................................................ IX V. List of Tables ............................................................................................................................... X VI. List of Appendices ................................................................................................................ XII 1 Problem statement ......................................................................................................................... 1 2 Financial asset valuation and pricing .............................................................................................. 7 2.1 Ad-hoc models ......................................................................................................... 9 2.2 Equilibrium models ................................................................................................ 11 2.2.1 Portfolio selection .......................................................................................................... 11 2.2.2 Capital asset pricing model ............................................................................................ 13 2.2.3 Models based on arbitrage pricing theory ....................................................................... 16 2.3 Intrinsic value models ............................................................................................ 19 2.3.1 Capitalization of income ................................................................................................ 19 2.3.2 Dividend-discounted model ........................................................................................... 21 2.3.3 Clean-surplus relation .................................................................................................... 23 2.3.4 Discounted cash flow model .......................................................................................... 24 2.3.5 Residual income valuation ............................................................................................. 25 2.3.6 Empirical tests of intrinsic value models......................................................................... 27 2.3.7 Ohlson model ................................................................................................................ 31 2.3.8 Feltham Ohlson model ................................................................................................... 34 2.3.9 Ohlson Juettner model ................................................................................................... 38 2.4 Concluding remarks ............................................................................................... 40 3 Discount rate ............................................................................................................................... 41 3.1 Risk-free rate ......................................................................................................... 42 3.1.1 Defining the risk-free rate .............................................................................................. 42 3.1.2 Identifying a risk-free asset ............................................................................................ 43 3.1.3 Dealing with reinvestment risk ....................................................................................... 45 3.2 Risk premium ......................................................................................................... 50 3.2.1 Defining the risk premium ............................................................................................. 50 3.2.2 Identifying risk premiums .............................................................................................. 52 3.2.3 Ex-post risk premiums ................................................................................................... 55 3.2.4 Ex-ante risk premiums ................................................................................................... 58 3.3 Concluding remarks ............................................................................................... 68 4 International portfolio investment ................................................................................................ 70 4.1 Investing in a global environment ........................................................................... 71 4.1.1 International-investment specific risks............................................................................ 71 4.1.2 Augmentation of the standard portfolio selection ............................................................ 72 4.1.3 International equilibrium models .................................................................................... 75 Table of Contents II 4.2 Integration of world markets................................................................................... 80 4.2.1 Market segmentation hypothesis .................................................................................... 80 4.2.2 Segmentation and equilibrium models ............................................................................ 88 4.2.3 International intrinsic value models ................................................................................ 92 4.3 Concluding remarks ............................................................................................... 95 5 The financial system in the People’s Republic of China................................................................ 97 5.1 Transformation of China’s economy ....................................................................... 98 5.2 The Chinese stock market ..................................................................................... 103 5.2.1 Establishment and structure of the Chinese stock market .............................................. 103 5.2.2 Current state of the Chinese stock market ..................................................................... 110 5.2.3 International investment in the Chinese stock market .................................................... 114 5.3 Concluding remarks ............................................................................................. 120 6 Asset pricing and valuation models in China .............................................................................. 121 6.1 Relevant aspects of the Chinese stock market environment ................................... 121 6.1.1 Integration of the Chinese stock market in the world market ......................................... 121 6.1.2 Irrelevance hypothesis in the Chinese stock market ...................................................... 124 6.1.3 Equilibrium models in the Chinese stock market .......................................................... 126 6.1.4 Intrinsic value models in the Chinese stock market ....................................................... 127 6.2 Concluding remarks ............................................................................................. 136 7 The Chinese discount puzzle ...................................................................................................... 137 7.1 Characterization of the Chinese discount puzzle ................................................... 138 7.1.1 The law of one price in the Chinese stock market ......................................................... 138 7.1.2 Price differences between A-, B- and H-shares ............................................................. 139 7.2 Suggested explanations and empirical evidence .................................................... 142 7.2.1 Speculation hypothesis ................................................................................................. 144 7.2.2 Information asymmetry hypothesis ............................................................................... 147 7.2.3 Differential demand hypothesis .................................................................................... 149 7.2.4 Differential risk hypotheses.......................................................................................... 150 7.2.5 Differential liquidity hypotheses .................................................................................. 151 7.3 Concluding remarks ............................................................................................. 153 8 Empirical analysis ..................................................................................................................... 154 8.1 Data ..................................................................................................................... 155 8.2 Relationship between foreign and domestic shares ...............................................