Abstract
There exists market segmentation in China's stock markets, in which local firms issued two classes of shares: class A shares available only to Chinese citizens and class B shares available only to foreign citizens. Contrary to what has been observed in other markets with a similar segmented structure, China B shares trade at a discount relative to A shares. After the Chinese Securities Regulatory Commissions opened the B-share market to Chinese citizens on February 19, 2001, the prevailing and persistent B-share discount dropped to 25 percent from its previous on average 75 percent. We exploit this new event and test the explanatory powers of different hypotheses on China's B-share discount puzzle. Our results support the differential risk hypothesis and liquidity hypothesis. We also document the effect of exchange risk factor on B-share discount through time.
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