Information Asymmetry and Asset Prices: Evidence from the China Foreign share discount

We examine the effect of information asymmetry on equity prices in the local A- and foreign Bshare market in China. We construct measures of information asymmetry based on market microstructure models, and find that they explain a significant portion of cross-sectional variation in B-share discounts, even after controlling for other factors. On a univariate basis, the price impact measure and the adverse selection component of the bid-ask spread in the A- and B-share markets explains 44% and 46% of the variation in B-share discounts. On a multivariate basis, both measures are far more statistically significant than any of the control variables. We also examine the behavior of B-share discounts after the B-share market was partially opened up to domestic investors after March 2001. Not only do we observe that B-share discounts decline from an average of 72% to 43%, but we also find that the differences in the adverse selection components across the markets shrink.