Puzzles in the Chinese Stock Market

Many companies on China’s stock markets have separate, restricted classes of shares for domestic residents and foreigners. These shares are identical other than who can own them, but foreigners pay only about one-quarter the price paid by domestic residents. We argue that the generally higher level (and volatility) of domestic share prices is consistent with the simplest asset pricing model, assuming plausible differencesabout 4 percentage-pointsin 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 characteristics affect the relative price paid by foreigners in a panel of companies. We find, for example, that foreigners pay a lower relative price for companies with a higher proportion owned by the statereflecting, surprisingly, a higher absolute price paid by both foreigners and domestic residents.