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Implications of stock ownership restrictions and asymmetric compensation for equilibrium asset pricing : theory and empirical evidence Diao, Xifeng

Abstract

In China the shares open to foreign investors, B-Shares, have much lower prices relative to shares open to domestic investors, A-Shares. In Chapter I, we study the impact of the monopolistic government within a general equilibrium framework, and explain why A-Share prices are higher than B-Share prices. Further, we provide a possible explanation of the relative size of A- and B-Share markets in China. We also apply our analysis to other countries and find implications different from the literature, in addition to the use a unified model of demand elasticity and liquidity in asset pricing. Chapter II explores the link between fund manager compensation and asset pricing in a setting where managers receive a larger reward per $1 profit than the penalty per $1 loss. This type of compensation, which we call UMC, is common in China, and leads to interesting results. In the final Chapter, we test the implications of Chapter I and Chapter II. Regarding Chapter I, we examine the values of A- to B-Share price ratios, the relationship between international betas of individual firms and the share issuance decisions as well as the price ratios of A- to B-Shares, and the impact of market liquidity on asset prices. All the findings from these tests are consistent with predictions of our model. Further, we show that the regime-switching (governmental) risk from foreign exchange rates also matters. In our empirical examination of the implications of Chapter II, we employ a method with improved efficiency over Fama-MacBeth (1973) and Ferson and Harvey (1999), and find a negative risk-return relationship in China, which is statistically and economically significant.

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