It takes two to tango: A regime‐switching analysis of the correlation dynamics between the mainland Chinese and Hong Kong stock markets
| DOI | http://doi.org/10.1111/sjpe.12110 |
| Author | Kin‐Yip Ho,Yanlin Shi,Zhaoyong Zhang |
| Published date | 01 February 2016 |
| Date | 01 February 2016 |
IT TAKES TWO TO TANGO:
A REGIME-SWITCHING ANALYSIS
OF THE CORRELATION DYNAMICS
BETWEEN THE MAINLAND CHINESE
AND HONG KONG STOCK MARKETS
Kin-Yip Ho*, Yanlin Shi* and Zhaoyong Zhang**
ABSTRACT
This paper proposes a regime-switching model to examine the correlation
dynamics of the mainland Chinese and Hong Kong stock markets with high-
frequency A-, B-, H-shares and Red Chip indexes. We find significant evidence
of volatility persistence and asymmetries in these markets. Our model further
suggests all correlations are significantly time-varying with various patterns and
co-persistence in both low- and high-correlation states. Our findings have
important implications for both policymakers and investors, such as understand-
ing the extent and nature of integration between the mainland Chinese and Hong
Kong stock markets over time and developing dynamic strategies for optimal
hedging and portfolio management.
II
NTRODUCTION
In recent years, China has emerged as a major global economic and trading
power. With its nearly double-digit growth rates for more than three decades
from 1979 to 2014, China is now the world’s second largest economy (the
largest economy based on purchasing power parity (PPP) in 2014, according
to IMF) and largest economy in merchandise trade and foreign exchange
reserves. China’s astonishingly rapid rise and its increasing economic promi-
nence are expected to reshape the international financial system, and drive
greater regional financial and economic integration. Ever since its inception in
the early 1990s, the Chinese stock market has experienced astonishing growth
and unprecedented development. According to the report by China Center for
Market Value Management (CCMVM) on 27th January 2010, as of the end
of 2009, the value of China’s A-share market rose 100.88 per cent year-on-
year to 24.27 trillion yuan (US$3.57 trillion). It overtook Japan’s share
market (US$3.53 trillion) and was second only to the USA share market (US
*The Australian National University
**Edith Cowan University
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12110, Vol. 63, No. 1, February 2016
©2016 Scottish Economic Society.
41
$15.08 trillion). Since then, it fell marginally behind Japan in 2010 and 2011,
and surpassed Japan again in 2012 with the market value amounting to US
$3.7 trillion, according to the World Federation of Exchanges (WFE). From
2013, the Chinese stock market has almost doubled in value, rising from US
$3.9 trillion to over US$6 trillion in 2014 and further to US$10 trillion for the
first time during the first half of 2015.
Hong Kong is the most closely related market of the mainland China, espe-
cially before its handover in 1997. Given its importance as an intermediary to
link up the mainland China with the rest of the world for foreign trade and
investment, the Hong Kong market is believed to be strongly integrated with
the mainland Chinese markets. As one of the largest financial centre in Asia,
the Hong Kong stock market ranked second in Asia and sixth in the world in
September 2013. Its market capitalization was US$3.1 trillion in 2013 and US
$3.23 trillion by 2014, according to the Hong Kong Exchanges and Clearing
Limited (HKEx).
As a result of their rapid development, the mainland Chinese and Hong
Kong stock markets have attracted a large number of domestic and inter-
national investors. Therefore, a growing number of securities and compa-
nies have joined these markets, especially in the recent decade. Table 1
presents the listed numbers of securities and companies for these markets.
It is observed that both figures have at least doubled over the past
13 years.
In order to regulate the trading, market segmentation has been enforced
in the mainland Chinese and Hong Kong markets. Four main types of
stocks, namely A-, B- and H-shares and Red Chip, are issued and traded in
separate markets. More specifically, both A- and B-shares are based in the
mainland China. A-shares are denominated in Chinese Renminbi and are
traded mainly by Chinese citizens. B-shares, however, are denominated in
US dollars on the Shanghai Stock Exchange and in HK dollars on the
Shenzhen Stock Exchange. They used to be traded solely by foreign inves-
tors until February 2001. After that, regulations were modified such
that the B-shares were open to Chinese citizens with deposit accounts in
foreign currencies. The H-share market refers to the shares of companies
Table 1
Listed securities and companies in the mainland Chinese and Hong Kong stock markets
Shanghai Shenzhen Hong Kong
1999 2004 2012 1999 2004 2012 1999 2004 2012
Listed Securities 574 996 2098 540 673 2190 1205 1971 6723
Listed Companies 484 837 954 463 536 1540 701 892 1368
Source: Shanghai Stock Exchange Fact Book (URL: http://english.sse.com.cn/aboutsse/publications/
factbook/c/factbook_us2013.pdf),
Shenzhen Stock Exchange Fact Book (URL: http://www.szse.cn/main/files/2013/05/28/101380619096.pdf),
Hong Kong Stock Exchange Fact Book (URL: http://www.hkex.com.hk/eng/stat/statrpt/factbook/
factbook2012/Documents/FB_2012.pdf)
42 K.-Y. HO, Y. SHI AND Z. ZHANG
Scottish Journal of Political Economy
©2016 Scottish Economic Society
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