Abstract
Starting from December 1, 2001, investors in Chinese stock markets are prohibited from selling B-shares that are bought on the same day. We investigate the impact of this so-called ‘T 1’ trading rule on B-share’s contribution to price discovery of the issuing firm. Because the tick size of trading B-shares in the Shenzhen Stock Exchange is 28% larger than that of trading B-shares in the Shanghai Stock Exchange, we expect this trading restriction has a greater impact on Shanghai B-shares than on Shenzhen B-shares. We find that while the T 1 trading rule significantly reduced trading volume and volatility in both Shanghai and Shenzhen B-shares, the reduction in Shanghai B-shares is greater than that in Shenzhen B-shares. Interestingly, the T 1 trading rule significantly reduced the effective spread in Shanghai B-shares, but had no impact on the effective spread in Shenzhen B-shares. The difference-in-differences analysis confirms that the liquidity in Shanghai B-shares improved after the adoption of the trading restriction. Consistent with the findings on volatility and liquidity, B-share’s contribution to price discovery increased significantly in Shanghai, but not in Shenzhen. In addition, the ratio of five-minute return variance to daily return variance decreased significantly in both Shanghai and Shenzhen markets, but the reduction is much greater in Shanghai B-shares than in Shenzhen B-shares. Overall, we learn from this natural experiment that excessive short-term trading can have a negative impact on liquidity and price discovery.
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