Puzzles in the Chinese Stock Market

Many companies on China’s stock markets have traditionall y had separate , restricted classes of shares for domestic residents and foreigners. These shares are identical other than for who can own them, but foreigners have generally paid only about one-quarter the price paid by domestic residents . We argue that the generally higher level (and volatility) of domestic share prices is consisten t with the simplest asset pricing model, assuming plausible differences—about four percentage points—in expected rates of return by foreign and domestic investors . We attribute low Chinese expected returns to the limited alternative investments available in China. We then estimate how various company characteristic s (including capital asset pricing model (CAPM) betas, company size, market liquidity, and other characteristics ) affect the relative price paid by foreigners in a panel of companies . We Ž nd, for example, that foreigners pay a lower relative price for companies with a higher proportion owned by the state—re ecting, surprisingly, a higher absolute price paid by both foreigners and domestic residents .