The stochastic spread strategy

The literature on contagion and spillover effect stresses that in some cases one stock market moves with no particular information release in the market justifying that move, but just because there are shocks in another stock market (Kaminsky and Schmukler, 1999). Financial headlines frequently report that investors’ moods spread across the A-share and B-share markets within the domestic frontier (Walter and Howei, 2001). Yang (2003) among others documents the cross-market information linkages between the A and B-share cross-markets. In this section, I examine whether the A (B)-share markets response to the regulatory events in the B (A)-share markets or whether there is cross-market spillover effect associated with regulatory events.

Table 3.9 shows the empirical results of parameter estimation for the modified GARCH (1,1)-M models with cross-market event dummy variables during the sample period which is from 2 January 1995 to 31 December 2003.

Table 3.9

Estimation Results of Modified GARCH (1, 1)-M Model with Cross-market Dummies

Coefficient SHA SZA SHB SZB

Panel A: Conditional Mean Equation (corresponding market dummies)

GARCH 0.0208 0.0214** -0.0022 0.0076

Constant -0.0015 -0.0002 -0.0028 0.0001

DBP(-1) 0.1018 0.0847 2.0579*** 1.3052***

DBP 2.2416*** 2.0195*** 4.6511*** 6.0534***

DBP(1) -0.3214 -0.0887 2.5631*** 1.7696*

DSS(-1) -0.0314 0.0963 0.5306 -0.6861

DSS -3.2594*** -3.0733*** -2.9977*** -3.0073***

DSS(1) -0.1169 -0.1721 -0.6654* -0.2871

MSE⁺ (-1) 0.1775 0.1271 -0.0303 -0.0024

MSE⁺ -3.1144*** -3.2460*** 4.2554*** 3.5610***

MSE⁺ (1) 0.2736 0.5385 0.2023 0.0359

MSE^- (-1) -1.1963*** -1.3064*** - -

MSE^- 4.0335*** 4.9115*** - -

MSE^-(1) 0.8138 1.0292 - -

TCC(-1) 0.4637 0.1984 -0.1002 -0.3912

TCC 1.4081*** 1.7219*** 1.2845*** 1.0784***

TCC(1) -0.5520 -0.5523 0.3033 0.3589

INT(-1) -0.1089 -0.0220 -0.0207 -0.0026

INT -0.0770 0.0014 -0.0176 -0.0126

INT(1) 0.0233 0.0054 -0.0094 -0.0061

AR(1)/MA(1) - - 0.0776*** 0.0736***

Panel B: Conditional Mean Equation (cross-market dummies)

^DBP(-1) 0.0578 0.2022 -0.0704 0.0298

^DBP 0.5813 0.6611 1.9383*** 1.7515***

^DBP(1) -0.4288 -0.4712 -0.0717 -0.0143

^DSS(-1) -0.3144 -0.4595 -0.2905 -0.1295

^DSS -0.9584 -0.6615 -0.5874*** -2.0203***

^DSS(1) -1.1703 -0.928** 0.0435 -0.5912

^MSE⁺ (-1) -0.3343 -0.1949 0.0522 0.3719

^MSE⁺ 0.5549 0.3296 -0.5916** -1.1568***

^MSE⁺ (1) -0.6898* -0.5596 -0.2533 -0.0773

^MSE^- (-1) - - -0.8304** -0.6260

^MSE^- - - 0.5849** 1.2000***

^MSE^- (1) - - -0.1966 0.4827

Table 3.9 (continued)

Estimation Results of Modified GARCH (1, 1)-M Model with Cross-market Dummies

Coefficient SHA SZA SHB SZB

Panel C: Conditional Variance Equation

Constant 0.6033*** 0.9903*** 0.0236 0.0003***

ARCH(1) 0.2203*** 0.4714*** 0.4159*** 0.4300***

GARCH(1) 0.6693*** 0.5203*** 0.5763*** 0.4775***

NTD 0.5300*** 0.7129*** 2.6728 0.8541

LMT -0.6063*** -0.9907*** 0.0208 0.0005

t-dist. d.f. 4.0046*** 3.6998*** 2.2343*** 2.1454***

Panel D: Residual diagnostic tests

Q(8) 11.2810 12.1340 11.5643 7.6483

Q²(8) 0.9491 1.8837 6.0977 3.0185

ARCH-LM 0.1159 0.5293 1.8230 0.4868

Notes:

1. ***, ** and * indicate that the test statistics are significant at the 1%, 5% and 10%

levels, respectively.

2. ^ indicates cross-market dummy variable.

In the conditional mean equations for SHA and SZA market, I add in ^DBP, ^DSS and ^MSE⁺ (including leading and lagging variables) as cross-market dummies, which take value of 1 whenever the specific kind of events occur only in the B-share markets. Similarly, in the conditional mean equations for SHB and SZB market, I add in ^DBP, ^DSS, ^MSE⁺ and ^MSE^- (including leading and lagging variables) as cross-market dummies, which take value of 1 whenever the events occur only in the A-share markets. The cross-market dummies take value of zero

the time when the news is relevant for both the A and B-share markets or whenever there is no news under the specific category²⁴.

Except the coefficients for the cross-market dummy variables, the coefficients for other variables as reported in Panel A, C and D of Table 3.9 are basically in line with those reported in Panel A, B and C of Table 3.8. This indicates that the findings in Section 3.4.2 are robust after including the cross-market dummies. As shown in Panel B of Table 3.9, the news releases in the A-share markets seem to have more cross-market spillover effects on the B-share market returns.

In particular, on the days when the A-share market demand boosting policy or measure is announced, the conditional mean returns of SHB and SZB markets are also statistically significant positive (which is 1.9% and 1.8%, respectively). It seems that the favorable market sentiment arising from the A-share market demand boosting policies and measures could spillover to the B-share markets.

On the days when the government authorities take disciplinary actions and strengthens the supervision of the A-share markets, SHB and SZB markets also drops statistically significantly. It seems that when the government authorities adopt the measures to curve the excess speculation and illegal trading in the A-share markets, the investors’ panic mood may also spillover to the B-A-share markets.

24 I do not include cross-market dummy in relation to transaction cost cut announcements as most such events are relevant for both A and B-share markets.

Both SHB and SZB markets respond to the A-share market supply expansion news as the empirical results show that the coefficients on ^MSE⁺ are negative and statistically significant. This finding is interesting when compared to the positive and statistically significant coefficients on MSE⁺ (regulatory dummy variable related to the market supply expansion news in the B-share markets themselves).

The coefficients on ^MSE^- are positive and statistically significant. In sum, on the announcement days to speed up or slow down the A-share market supply expansion, the B-share market indices move in the same directions as the A-share market indices. The phenomenon shows that although A-share supply shocks have no direct implication for the B-share market fundamentals, the B-share investors’

psychological behaviors may be influenced by the market sentiments in the A-share markets, and the stock index performance of B-A-share markets follows that of the A-share markets, which dominate the Chinese stock markets.

In all, for the news related to demand boosting policies and measures, disciplinary actions and strengthening of supervision which reduces demand and market supply expansion, the cross-market spillover effects from the A-share markets to the B-share markets occur on the event days, evident by the statistically significant coefficients for ^DBP, ^DDS, ^MSE⁺ and ^MSE^- for SHB and SZB markets. But the magnitudes of the parameters for cross-market A-share event dummies ^DBP, ^DDS and ^MSE⁺ are all smaller than those for B-share event dummies DBP, DDS and MSE⁺. Chi-square statistics of Wald-test further confirm that for SHA and SZA markets, the coefficients for each pair of regulatory event

dummies (^DBP v.s. DBP, ^DDS v.s DDS and ^MSE⁺ v.s MSE⁺) are different at the 1% significance level.

However, the cross-market spillover effects from the B-share markets to the A-share markets are weak. As for SHA market, the only statistically significant coefficient for the cross-market dummy variables is that for ^MSE⁺ (1), which is negative and indicates that SHA market return drops one trading day after market expansion news is announced in the B-share markets. The possible explanation is that after B-share market expansion, more A-share only companies will be dually listed on B-share markets. While B-shares are traded at large discounts to their A-share counterparties and there will be a wealth transfer from the A-A-shareholders to B-shareholders. So that B-share market expansion might be a bad news for some domestic investors. As for SZA market, the only statistically significant coefficient for the cross-market dummy variable is that for ^DSS(1), which is negative and indicates that SZA market return drops one day after disciplinary actions and strengthening of supervision take place in the B-share markets. This phenomenon shows that the negative market sentiment arising from the B-share market disciplinary actions and strengthening of supervision could spillover to the A-share markets.