A Resolution of the Chinese Discount Puzzle

On February 19, 2001, the Chinese Securities Regulatory Commission announced that Chinese residents would be allowed to own B-share classes of stocks traded on both the Shanghai and Shenzhen stock markets. These share classes were previously restricted to foreign investors while domestic residents were only permitted to hold A-share classes of stock. This regulatory change triggered a dramatic decline of prevailing B-share discounts of 75 percent down to 8 percent. We examine the changes in B-share discounts across 75 stocks and how they relate to fundamental attributes of the stocks in order to distinguish among various hypotheses that have been put forward for the existence of the so-called Chinese discount puzzle. That is, why B shares are traded at discount rather than at usual premium. We find that the decline in the B-share discount around this regulatory event is concentrated in small capitalization stocks and those with substantial past-return momentum and is unrelated to the firm's risk and liquidity attributes