Testing for expected return and market price of risk in Chinese A and B share markets: A geometric Brownian motion and multivariate GARCH model approach

There exist dual listed stocks which are issued by the same company in some stock markets. Although these stocks bare the same firm-specific risks and enjoy identical dividends and voting policies, they are priced differently. Some previous studies show this seeming deviation from the law of one price can be solved by allowing different expected returns and market prices of risk for investors holding heterogeneous beliefs. This paper provides empirical evidence for that argument by testing the expected return and market price of risk between Chinese A and B shares listed in Shanghai and Shenzhen stock markets. Models with dynamic of Geometric Brownian Motion are adopted. Multivariate GARCH models are also introduced to capture the feature of time-varying volatility in stock returns. The results suggest that the different pricing can be explained by the difference in expected returns between A and B shares. However, the difference between market price of risk is insignificant for both markets if GARCH models are adopted. © 2009 IMACS. Published by Elsevier B.V. All rights reserved. JEL classification: C1; C32; G12