Investor Composition and Stock Return Patterns: A Study of Momentum in the Chinese A- and B-Shares Markets

Abstract

Listed Chinese companies can issue A-shares that are held mainly by domestic investors and B-shares that are held mainly by foreign investors. Although these twin shares have identical cash flow rights and are traded in the same location, A-shares are almost always priced higher than B-shares. A-shares also exhibit substantially higher turnover, suggesting that the clientele holding these shares trade more actively than the B-share investors do. To describe the relation between the returns in these markets we provide a descriptive model where the A-share market is in some sense more and in some sense less efficient than the B-share market. Because insiders trade in the A-share market, prices capture information faster than that in the B-share market. However, A-share market participants also trade on noise. We also assume that all market participants are overconfident about their prior beliefs, and thus underreact to fundamental information and ignore information embedded in stock prices. The model generates momentum for B-shares and reversals for A-shares as well as cross-predictability, i.e., A-share (B-share) returns predict future B-share (A-share) returns. We provide empirical evidence that is consistent with all of these predictions.