Understanding AH Premium in China Stock Market

There are 88 companies (AH-share) dual-listed in both China mainland

stock market (A-share) and Hong Kong stock market (H-share) accounted

for 20% of total A-share. The .Shanghai-Hong Kong Stock Connect.pro-

gram starting at November, 2014 makes previously two segmented markets.

Shanghai and Hong Kong stock markets-connected. The price difference of

AH-share in Shanghai and Hong Kong stock markets, measured by Hang

Seng China AH Premium Index, persistently divergences instead of converging ,

and even reaches 50% higher in Shanghai market. We have shown that

present-value asset pricing models with heterogeneous agents cannot generate

any price difference. Transaction cost and different dividend taxes between

Shanghai and Hong Kong markets also quantitatively fails to explain such

high and volatile AH premium. We, hence, propose an ‘Internal Rationality’

learning model, in which agents don.t know the pricing function from

fundamentals to the stock prices and have different subjective beliefs about

tomorrow’s capital gains in Shanghai and Hong Kong markets. Our learning

model can successfully generate data-like weekly AH premium. We also show

that convergence traders with strategy short in Shanghai and long in Hong

Kong will lose money with 33% probability.