The Book-To-Market Anomaly In The Chinese Stock Markets

Kin-Yip Ho

The Australian National University – School of Finance, Actuarial Studies and Applied Statistics, College of Business and Economics; Financial Research Network (FIRN)

Jiyoun An

Kyung Hee University

Lanyue Zhou

University of International Business and Economics (UIBE)

September 30, 2015

Journal of East Asian Economic Integration Vol. 19, No. 3 (September 2015) 223-241

Abstract:

This paper examines the existence of value premium in the Chinese stock markets and empirically provides its explanation. Our results suggest that the value premium does exist in the Chinese markets, and investor sophistication is significant in explaining its existence. In particular, there is supporting evidence that the value premium could be driven by individual investors, whereas stocks that are mostly held by institutional investors are value-premium free. We briefly discuss the implications of our findings.

The Book-To-Market Anomaly In The Chinese Stock Markets

The book-to-market effect (otherwise known as the “value premium” effect) is an empirical regularity that stocks with high book-to-market (BM) ratios (low market prices relative to the book values of equity) earn higher average (riskadjusted) returns than stocks with low BM ratios. Many previous asset pricing studies suggest that the existence of value premium can be explained from either the perspective of risk or the influence of mispricing factors.? Findings from these asset pricing studies extensively rely on datasets from the U.S. stock market which not only has a large pool of global institutional investors but also is considered a relatively efficient market.

Previous studies such as Fama and French (1998 and 2012) and Asness, Moskowitz and Pedersen (2013) have also confirmed the existence of value premium in international financial markets. However, value premium could exist in various markets with different explanations. For example, risk-based explanation has built on the efficient market hypotheses. Those explanation may fit in the U.S. market, but not in other less developed and less efficient markets such as the Chinese market. Drew, Naughton, and Veeraraghavan (2003) and Euna and Huang (2007) have shown that the value premium exists in Chinese markets. However, they have not provided its explanation.

Unlike previous studies, this study goes further by providing the explanation for the existence of value premium in Chinese markets. We notice that the Chinese stock market is a natural candidate for testing whether individual investors drive value premium with the following reasons. First, the mainland Chinese stock markets are often perceived as “casinos driven by fast money flows in and out of stocks with little regard for their underlying value” (Wall Street Journal, August 22 2001). In addition, the segmentation of the markets and the predominance of individual investors in these markets make the Chinese stock market a natural candidate for testing whether individual investors drive value premium.

Our results confirm that, like Drew et al. (2003) and Eun and Huang (2007), the value premium does exist in the Chinese markets for the period from 1994 to 2010. Moreover, there is a significantly negative relationship between institutional ownership of stocks and value premium. This is apparently consistent with findings of Phalippou (2007, 2008) that value premium is related to trading activities of individual investors, not institutional investors in the U.S. market.

Our findings with the Chinese firms contribute to empirical asset pricing literature by providing international supporting evidence that the value premium could be driven by individual investors, whereas stocks that are mostly held by institutional investors are value-premium free.

The rest of the paper is organized as follows. Section 2 reviews the literature regarding the value premium, the characteristics of the Chinese stock markets and develops several testable hypotheses. Section 3 then discusses the datasets and explains the empirical methodology. The empirical results are analyzed in detail in Section 4. Finally, this paper concludes by discussing the implications of our results for policy regulators, the role of institutional investors, and the overall market efficiency in China.

Chinese Stock Markets

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