Information asymmetry, market segmentation and the pricing of cross-listed shares: theory and evidence from Chinese A and B shares

Abstract

In contrast to most other countries, Chinese foreign class B shares trade at an average discount of about 60% to the prices at which domestic A shares trade. We argue that one reason for the large price discount of B shares is because foreign investors have less information on Chinese stocks than domestic investors. We develop a model, incorporating both information asymmetry and market segmentation, and derive a relative pricing equation for A shares and B shares. We show theoretically that an A share index security, tradable by foreigners, increases the liquidity of B shares. Our empirical study of Chinese stocks supports the predictions of our model. Specifically, we show that our model-based proxies for information asymmetry explain a significant portion of the cross-sectional variation of the B share discounts.