Abstract
We investigate whether idiosyncratic risk and investor sentiment play important roles in the price disparity between China A-shares and H-shares. To build the investor sentiment indices and decompose them into different fragments for both markets, we use both principal component analysis (PCA) and partial least squares (PLS) approaches. We further look at how idiosyncratic risk affects stock mispricing and how it deals with investor sentiment. We find that the price premium of A-shares over H-shares is strongly linked to the sentiment differential. We also discover that idiosyncratic risk has a major effect on the price premium of cross-listed companies. Moreover, a larger sentiment differential reinforces the impact of idiosyncratic risk on the price disparity. The above results remain robust after controlling for other economic factors.
Highlights
International diversity attracts free capital moving across borders, and numerous companies have gained capitals outside of their home countries over the last few decades
The findings in Column (1) of Panel A reveal that by using principal component analysis (PCA) approach, the difference in investor sentiment between the two markets plays a critical role in deciding the price disparity of cross-listed stocks
In evaluating the price disparity, we compare the results of PCA and partial least squares (PLS) investor sentiment indices
Summary
International diversity attracts free capital moving across borders, and numerous companies have gained capitals outside of their home countries over the last few decades. The price disparity of cross-listed companies has been discussed for years, there has been comparatively limited literature on both investor sentiment and idiosyncratic risk. It is an innovative exercise to use both PCA and PLS methods to build investor sentiment to investigate price deviations in cross-listed securities. Prior studies have confirmed that differences in demand, liquidity, risk, and information asymmetry are associated with the underlying stock price premium (Bailey & Jagtiani, 1994; Chakravarty et al, 1998; Chan et al, 2008; Grossmann et al, 2007; Karolyi et al, 2009; Mei et al, 2005; Rui et al, 2007; Stulz, 1981; Stulz & Wasserfallen, 1995; Sun & Tong, 2000; Wang & Jiang, 2004). Fourth section presents the empirical results, and fifth section summarizes and draws conclusions
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