Essays on the Cross-listed Chinese Securities

This dissertation studies the violation of the Law of One Price across Chinese stocks that are traded at multiple markets. According to the Law of One Price, the cross-listed shares of a Chinese stock should have same prices after currency and transaction cost adjustments if markets were efficient. However, the shares traded in Mainland China are trading at a premium over the shares traded in Hong Kong or U.S. I argue that the presence of short-sales constraints in Chinese markets is one of the major reasons for the over-valuation of the domestic shares traded in Mainland China.;Chapter 1 examines a sample of Chinese securities that have its shares traded in Mainland China, Hong Kong, and U.S. stock markets. I find that the domestic shares (A-share) are persistently and significantly traded at a premium relative to the foreign shares (H-share and ADR). Besides, the A-share return tends to be less volatile than the H-share and ADR return. When analyzing the shares of each stock in pair (A-H and H-ADR), the log price-ratios of the share pairs appear to be stationary. While price ratios of the H-ADR pair exhibit instantaneous mean reversion, price ratios of the A-H pair have slow mean reversion. Furthermore, I find the return differentials of the share pairs exhibit positive correlations with their respective market return differential, but negative correlations with the one period lagged return differential (for the H-ADR pairs only). I argue that the over-valuation of domestic A-share and its distinctive convergence properties can be attributed to the binding short-sales constraints in Chinese markets.;Chapter 2 develops an asset-pricing model in an attempt to explain the over-valuation of domestic A-share relative to its counterparts, the H-share and ADR. The model takes into account two market frictions in Chinese financial markets, foreign ownership restriction and short-sales constraints, while allowing for heterogeneous beliefs among investors. I show that the difference in A- and H-share prices (A-H share premium) can be attributed to three effects: the risk-sharing effect, the short-selling effect, and the asset-float effect. The short-selling effect is induced from the A-share price due to the short-sales constraints on A-share. The risk-sharing effect comes from the H-share price as the investors in Hong Kong are able to diversify their portfolio risk by investing in foreign assets while investors in Mainland China cannot. The asset-float effect arises because of the difference in floats (or tradable shares) between the two shares classes. In addition, the model helps explain how the return and volatility of the two share classes may differ as a result of the short-sales constraints. The results are consistent with the empirical findings in Chapter I.;Chapter 3 presents an institutional analysis of the Chinese financial markets, in particular on the cross-listed Chinese securities. I provide some stylize facts about the cross-listed Chinese stocks and discuss the major reforms carried out by the Chinese government over the last decade as a continual effort to liberalize the Chinese financial markets. Moreover, I survey the literature on the possible hypotheses for the over-valuation of domestic A-share.