Testing for Expected Return and Market Price of Risk in Chinese A-B Share Markets: A Geometric Brownian Motion and Multivariate Garch Model Approach

Abstract

There exists the phenomenon of so-called dual listed stocks in some security markets: companies are allowed to issue different types of stocks facing segmented investors. Although these stocks share the same firm-specific risk, and enjoy identical dividend and voting policy, the price of these different types of stocks is not the same and the so-called pricing puzzle arises. Some previous studies show this seemingly deviation from the law of one price can be solved due to different expected return and market price 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-share stocks. Models with dynamic of Geometric Brownian Motions 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 the expected return and market price of risk between A and B shares in Chinese stock markets. However, the significance of the difference between market prices of risk becomes disappearing for both markets if GARCH models are used.