Stock Market Openness and Market Quality : Evidence from the Shanghai-Hong Kong Stock Connect Program

This paper studies the impact of capital market openness on high frequency market quality in China. The Shanghai-Hong Kong Stock Connect (SHHKConnect) program opens China's stock market to foreign investors and offers a natural experiment to investigate this question. Using a difference-in-differences approach, we find that market liberalization leads to lower bid-ask spread, lower effective spread, lower market depth and higher short-term volatility. Our findings imply that opening the markets to more sophisticated foreign investors is associated with higher competition and more cross-market arbitrage activities, narrowing the spread and reducing liquidity providers' profits, but increasing the price impact and short-term volatility of connected stocks