Market Efficiency and the Heterogeneous Impact of Financial Liberalization: Evidence from the Shanghai-Hong Kong Stock Connect

TL;DR

This study investigates how the Shanghai-Hong Kong Stock Connect influences the A-H share price premium, revealing that its impact varies with market efficiency levels and emphasizing the importance of market conditions for policy effectiveness.

Contribution

It provides empirical evidence that financial liberalization's effects on price premiums are heterogeneous and depend on pre-existing market efficiency levels.

Findings

Stock Connect increases A-H price premium by 18.4%.

The effect is stronger in less efficient markets.

No significant response at the announcement stage.

Abstract

This paper examines how the Shanghai-Hong Kong Stock Connect (SHHK Stock Connect) affects the A-H share price premium and whether the policy effect depends on pre-existing market efficiency. Using monthly data for 67 A-H dual-listed firms from 2011 to 2019, we estimate dynamic models using system GMM. We find that the implementation of SHHK Stock Connect is associated with an average 18.4% increase in the A-H price premium, indicating a widening rather than a narrowing of the A-H share price premium. More importantly, this effect is heterogeneous: the policy impact is more pronounced for firms operating in less efficient markets and weaker for those with higher efficiency. We find no significant pricing response at the announcement stage. These findings imply that financial liberalization does not necessarily promote cross-market price convergence; its effects depend on pre-existing market efficiency, suggesting that cross-border liberalization policies may be more effective when accompanied by improvements of market efficiency.