Structural breaks, cointegration and B share discount in Chinese stock market

The Chinese Stock market had a special feature up to 2001 in that the stocks trading was segmented according to the type of investor (domestic and foreign). Since companies can issue both A shares (for domestic residents) and B shares (foreign investors) and the legal status of these shares are the same, they would be expected to have similar fundamental expected dividend flows. If discount rates are fixed this should imply that the share prices will be cointegrated. We test this proposition and find that there is no evidence for a long-run relationship for the time period under investigation. Then we show there are two structural breaks, corresponding to the regulatory shift in 2001 and the Asian financial crisis. After correcting for these structural breaks, we identify long run relationships and consider reasons for why such a relationship exists. By doing so we are able to throw some light on why there is a significant discount on B shares relative to the same share traded in the A market.