Political risk and stock returns: The case of Hong Kong

This thesis consists of two papers. In one paper, standard event study methodology was employed to examine Hong Kong stock market reactions to re-domicile announcements of a sample of 41 Hong Kong companies for the time period March 1984 to December 1991. Empirical results indicate that investors reacted negatively to re-domicile announcements. When the sample was disaggregated and analyzed by individual industry sector, industrial companies, consolidated enterprises and property companies are shown to have experienced significant losses, while financial companies and shipping companies experienced significant gains following the announcements. Although it might be postulated that shareholders in Hong Kong and abroad should benefit in terms of political risk reduction by investing in re-domiciled companies, it was found that re-domicile announcements also relayed adverse messages, such as selectivity bias, liquidity risk, and the implication of a confidence problem. These negative perceptions could explain negative reactions to the announcements. Financial companies and shipping companies received positive reactions because of their industry specific characteristics.; In the other paper, the impact of Sino-British negotiations over the future of Hong Kong on Hang Seng Index (HSI) returns during 1982--1984 was investigated. Under the framework developed by Fama (1990), quarterly HSI returns were regressed on macroeconomic variables, such as real GDP growth rates and inflation. Only 32% of the variation of the HSI returns were found to be explained by these economic variables. The addition of two political risk dummy variables, which capture the Sino-British negotiations and the Tiannanmen incident, significantly increased the explanatory power of return regression to 48%. The empirical results show that real shocks, such as political events, have a large impact on stock returns. The effects of headline news associated with the Sino-British negotiations on daily HSI returns were also examined. The headline news from major Hong Kong newspapers was partitioned into good news, bad news, anticipated news and unanticipated news. The empirical findings indicate that the market responded positively to good news and negatively to bad news. More importantly, the market responded significantly to unanticipated news and insignificantly to anticipated news.