China achieved an extremely rapid economic development in past 10 years, it remained over 8% increase rate of GDP from 2000 to 2009 and this kind of tendency is continuing (chart 1). The quick development of economy in China has be an interesting issue for debate. Several factors attribute to the development of economy and one of these factors, development of finance, is highly considered since it provide large capacity and flexibility for corporative finance in capital market. Many researchers have studied the relationship between growth of economy and development of finance and positive interaction has been found. For example, Rajan and Zingales (1998) discovered that the cheaper funds which generated from the development of finance are beneficial to the growing industries, thereby leading to the growth of economy. Nourzad (2002) convinced this positive causality by analyzing another aspect of economy and it found the developed financial sector accelerates the efficiency of productivity. When explain the economic development through financial aspect, the role of stock market should be highlighted. It is acknowledged that stock market is the significant component element of finance, which directly reflects in which extent a country's finance is active and positive. Levine and Zervos (1998) can be a strong evidence for this viewpoint which ascertains stock market leads to faster economic growth by providing convenient approaches in aspects of assets trading, banking system changing and capital accumulating. Due to the significance of stock market, it is meaningful to analyze and evaluate a country's stock market for a deeper understanding in terms of economy and finance.
China established its first stock exchange in Shanghai in 1990 and another exchange in Shenzhen in the following year. The unique character of Chinese stock market is the classification of A-share and B-share in both exchanges. More precisely, A-share can be only traded among domestic investors and denominated in Chinese RMB, B share, on the other hand, traded in US dollar in Shanghai and HK dollar in Shenzhen, which open to foreign investors. The Chinese stock market achieved great development after the establishment of these two stock exchanges and more than 1000 domestic companies are listed until 2000, the market capitalization accounts for 33.4% of GDP in the same time (Green, 2001). It accelerated its development after several regulation changes due to the participation of WTO and now it has become one of the largest stock market in Asia which significantly influences the global economy. However, arguments about this market are always existed and the fiercest point is whether the Chinese stock market efficient despite the great development. Efficiency is a crucial issue of market which determines the validity of fund supplying function of capital market and adjusts the stock price to a normal level. Some researchers argued that Chinese stock market are inefficient and several underlying problems existed behind its resplendence. Franklin Allen (2007) stated Chinese stock market lack of essential factors in terms of complete laws and effective institutions, corruption was rampant and fast development was based on self-fundraising which is not substantial. Shanghai index sharply increased from over 1000 in 2005 to 6100 in 2007 and then suddenly declined to 1700 at the end of 2008. The recently abnormal performance aggravated the doubt about efficiency.
This purpose of this study is to test the efficiency of Chinese stock market in the first place. I will focus on the performance of recent years from 2005 to 2009 and tend to analyze whether this market is efficient after both rapid development and intense turmoil. Based on the first step analysis, I hope to explain the causes of such situation from particular aspects such as the structure of market, regulations, economic policy and environment. Several suggestions will be proposed to improve and maintain Chinese stock market. I believe that it is meaningful and urgent for the domestic economic development, but in the meantime, it is also important for global investors and researchers to understand this emerging market and identify its opportunities and risks.
The level of efficiency the only criterion determines in which extent a stock market is a potential and effective capital allocator. “Efficient” is generally means the transaction of a stock are based on a reasonable price and such price can roughly reflects the intrinsic value of the stock. Eugene Fama defined the efficient stock market in the first place in 1970 by putting forward “efficient market hypothesis”. In this study, he argued that an efficient stock market reflects all available information accurately and immediately, therefore, it is impossible to make any profit by studying any relevant information since asset prices incorporate such information fully and timely and the asset returns are unpredictable. He also classified three types of efficiency depending on different extents of reflected information. Weak-form of EMH suggests that prices completely reflect all historical information. Moreover, this form of EMH is generally associated with random walk theory which indicated the future price is randomly and it is independent of past price change. Semi-strong form of EMH asserts prices not only reflect historical information but also all publicly information about stocks such as earnings, book value and so on. In strong-form of EMH, even private or insider available information would be incorporated into stock's price, therefore, not only normal investor, but professional analysts and managers also have no opportunities to outperform the index or listed stocks.
EMH broadened the horizon of researchers and led them to test the level of efficiency in many different markets and several statistical and mathematical approaches are appeared and widely utilized. Accompanied by the emergence of Chinese stock market, many researchers were attracted by its fast development and devoted to study this market. Mookerjee and Yu (1999) test the weak-form EMH of Chinese stock market by using serial correlation and runs tests; they selected daily data both from Shanghai and Shenzhen exchanges during 1990 to 1992 for their test and found neither exchange's index series supported the random walk theory. This study attributed the inefficiency to inadequate information generated from limited regulations and legal infrastructure. Hsiao (1996) tests a large number of individual stocks in shanghai stock exchange by using three standard weak form tests in terms of autocorrelation test, variance ratio test and runs test. This study concluded that both A and B share in shanghai stock market were rejected by random walk theory, in particular, B share is strongly correlated between the price changes. Ma and Barnes (2001) extended its analysis by examining both index level and individual price data from shanghai and Shenzhen markets between 1990 and 1998. They found the weak-form of EMH in A share but convinced the B-share was still not efficient and argued the thin trading as a important reason for inefficiency. Li (2003) confirmed Ma and Barnes (2001)'s found by using update data but indicated that Chinese stock market revealed a steady movement towards efficiency. This study attributed the found to loosened regulation which provide an access for domestic investors to analyze and compare information to their foreign counterparts. Because of the requirement of economic globalization, researcher tended to test the efficiency of Chinese market and compare with other market as well. Laurence (1997) confirmed the weak-form in A-share and illustrated the internal and external linkages between markets. It found the statistically linkage between Chinese market was weak but such causal effect was strong between china and US.
On the other hand, there are also some researchers used non-statistical or non-mathematical methods to evaluate the efficiency of Chinese stock market because they believed that the different date and samples involved in traditional methods will influence the accuracy of results and different statistical and mathematical methods also lead to different results. Based on Fama (1970), information is the determinant of efficiency; therefore, event research is emerged. Ma (2004) analyzed the change of stock prices after new announcements and it found new information was not incorporated into prices immediately and abnormal returns are existed, which against the basic hypothesis. Malkiel (2007) analyzed if the professional investors outperform index funds in Chinese stock market by proposing the more inefficient the market, the more opportunities for professional earn higher risk-adjusted returns then normal investors since their position might helpful to study information or obtain insider information. The abnormal returns are found in A-share which suggested its inefficiency.
Researchers also tended to study underlying reasons what influence the level of efficiency of Chinese stock market. The 6th HKIMR china workshop argued that Chinese stock market will enhance its efficiency due to the continuing industrialization and globalization but the structure of bank, institutional investors and existed regulation exerted negative effects. Green (2003) also emphasized unsubstantial market size, role of state-owned enterprise and irrational investor behaviors should be noticed in the process of improving more efficient stock market in china.
The theoretical principle of this whole study is efficient market hypothesis since all the analysis of level of efficiency of stock market in china, discussion about influence factors of efficiency and suggestions about improvement of efficiency involved in this study are derived from EMH. More precisely, the significant argument in EMH which is available information effective reflected in stock price as a base back up the study's whole process. Therefore, this study will generally follow the hypothetico-deductive methodology.
The first stage is to test the efficiency of Chinese stock market by using Event Research approach. I tend to analyze the returns of stocks before and after the announcement of annual financial report and find if there are premium returns in this duration. This approach of test is in accordance with the hypothesis of EMH which can reflect in which extent the market response related information. Capital assets pricing model will brought in my test. The detailed test processes are following:
After the calculation of rjt and rmt,ɑj and estimatedβj can be calculated by using regression analysis.
If the premium returns are significantly existed in long time, the market efficiency is low, vice versa.
The data involved in this test will select from the data base of Shanghai and Shenzhen stock exchange and all stocks will selected from A-share market.
The second stage is test the efficiency of Chinese stock market from non-statistical and non-mathematical aspect. I will use the theory called “law of one price” for the principle of test. This theory stated that one identical good must have identical price in different markets because the violation of this law will lead to abnormal price and opportunities for arbitrage. This theory is also applicable in stock market to test the market's efficiency since if all market are fully efficient and can reflect any information immediately and completely, the stock price will identical and any opportunities for abnormal returns are rejected. There are several Chinese companies listed in domestic and US exchanges at one time and if analyze the change of price in a particular time and compare the prices, the level of efficiency of stock market can be distinguished. US stock market has been confirmed that a higher level of efficiency (Gersdorff, 2009, Longworth, 1981 & Sanger, 1986) than Chinese stock market, therefore, the lower efficiency of Chinese stock market can be identified if the prices of same stock in these two markets are different.
The source of data is mainly about price of stocks and relevant available information about companies, which can be collect from the data base of these two stock markets. Particular period and time will be set for a clear and objective observation and comparison and several graphs will showed to illustrate the changes of prices.
After those tests, the third step of the study will followed to explain what factors contribute to the certain extent of efficiency of Chinese stock market and how to improve the efficiency of this stock market. This kind of analysis are mainly based on the viewpoints from previous researches and some of them have been described in the literature review part in terms of institutional structure, role of bank, regulation, SOE and market size. I will evaluate the contemporary situation of Chinese stock market and analyze both the positive and negative influences attribute to changes. After these researches, I tend to state some suggestions for improving this stock market. Particularly, I will focus on what influence and how to enhance the informational efficiency of this market since it consistently with the principle of this research. The required data can be collected from existed materials in terms of regulation, laws and published surveys. Moreover, the update information also can be collected by interviewing practitioners and investors.
Due to the time restriction of this study, I only select A-share in Chinese stock market for the sample to test the efficiency. It is reasonable since this type of stock is mainly invested by domestic investors and it accounts the largest scale for the Chinese stock market, which might represent the whole market in certain extent. However, accompanied by the loosening restriction, the proportion of foreign investment in A-share is increasing gradually and domestic investors also allowed trading in B-share, those changes might influence the accuracy of test if which only test one type of share. Furthermore, in the test stages I assume there are no transaction fees and tax effects in Chinese stock market since which can simplify the process of test and more consistently with the basic theory. But in practice, the perfect condition is not existent and those factors really affect the market.
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