Market Segmentation and Share Price Premium

In China, domestic firms can issue both domestic (A) and foreign (B or H) shares. Domestic investors can only invest in A-shares and foreign investors only in B- and H-shares. Unlike other emerging markets, domestic A-shares are sold at a premium relative to foreign shares. We conjecture that the premium for domestic shares is determined by the limited alternative investment opportunities available to retail investors. The empirical evidence indicates that cross-sectional variation in the premiums for A-shares is negatively related to the relative supply of A-shares, and positively related to the relative supply of foreign shares. There is also evidence that the premiums can be explained by the speculative nature of retail investors, liquidity risk and firm size (market value of free-floating shares).