What Determines Chinese Stock Returns?

Size, not book-to-market, helps to explain cross-sectional differences in Chinese stock returns from 1996 to 2002. Similar to the U.S. experience, beta does not account for return differences among individual stocks. Due to the speculative nature of Chinese capital markets and the low quality accounting information, these results suggest that the book-to-market variable may have failed to reflect fundamentals in Chinese markets. Instead, we have proposed using a floating ratio as a proxy for fundamentals because of the unique structure of the traded Chinese companies. Floating ratio may have reflected the expected corporate governance in China, which helps to predict a firm's future cash flow. Not only the cross-sectional evidence strongly supports our prediction for the floating ratio variable, a three-factor model which includes size and floating ratio proxies has significantly increased the explanatory power of a market model from 81% to 90%