The Effect of Investor Protection

This paper tests the hypotheses that poor investor-protection environments lead to higher information asymmetry in security markets. We compare China-based stocks, which operate in a relatively unprotected environment, to Hong Kong-based stocks. The information component in the market friction of China stocks is shown to be up to 20% larger than that of Hong Kong-based stocks. The effect is robust and remains so even controlling for trading variables and market capitalization. By empirically validating the assumption made in Brockman and Chung (2002), we contribute to the literature on the economic importance of investor protection, as well as that on cross-sectional determinants of asymmetric information. 1 M.Phil. student and associate professor of Tsinghua University and professor of City University of Hong Kong. Corresponding author: Yihui Wang. Email: [email protected]. Voice: (852) 2788-7022. Fax: (852) 2788-8614 The work described in this paper was fully supported by a grant from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project No. CityU 1081/02E).