Jian Huang

Date of Award

6-2023

Advisor(s)

Hemao Wu

Second Advisor

Yi Tang

Abstract

The stock market is a significant place for capital allocation where paternalistic securities regulation is a necessary choice to hedge against risks in a growth-oriented capital market and enhance efficiency of capital market. However, paternalistic regulation can also lead to behavioral failure and amplify market failure, thus resulting in a decline in market efficiency. This dissertation attempts to empirically reveal that it is one of the objectives of securities regulation to increase the stock direct financing ratio (DFR), but policy adjustments can cause increased market volatility, and a stock market with increased volatility may exhibit overreactions, a phenomenon that is weaker than weak-form efficiency. This study aims to provide valuable help for securities regulation to minimize significant stock market volatility, improve investor rationality, and enhance capital allocation efficiency.

The analysis herein identifies two abnormal performances in the Chinese stock market: the discrepancy between returns and economic background and the failure of synchronous increase of DFR with the enlarged market size. Based on these observations, this dissertation discovers that securities regulation has been establishing a multi-tiered capital market, cultivating qualified investors (including foreign investors) to enter the market, and responding to market booms and busts with various policies for the main purposes of enhancing the allocation effectiveness and efficiency of the stock market in both the capital market and the economic society, as well as addressing the aforementioned shortcomings. The value of stock market has grown at a compound growth rate of 1.84 times the GDP, reaching approximately 70% of the GDP recently. However, the DFR has remained below 5% in the long term, indicating that the stock market has grown rapidly, but the allocation efficiency of direct financing has not been effectively improved. Therefore, this dissertation provides a comprehensive review and empirical analysis from three perspectives: the objectives of regulation; regulatory objectives and regulatory policy adjustments; regulatory policy adjustments and market reactions.

This study finds that it is one of the long-term objectives of Chinese securities regulation to increase the DFR, and the method to achieve such objective is by generating wealth effects in the stock market (Hypothesis 1). Through yearly (for the period from 2002 to 2021) and monthly (for the period from January 2012 to December 2021) correlation analysis and robustness test on the index and financing scale DFR and stock returns, and as result of fact review, this dissertation provides evidence for H1. The national planning shows that securities regulation is responsible for increasing the DFR, and regulators also believe that this is beneficial for economic development and financial risk prevention. The correlation analysis results exhibit that both the monthly and annual stock financing increments are significantly and positively correlated with the stock index. In terms of sensitivity, the recent wealth effects have a more significant influence on investors. However, considering the implementation cycle of the issuance market, the significant correlation of the DFR with the stock market returns in the previous year is much greater than with that in the current year. This finding provides insights into the drivers of frequent policy adjustments in Chinese securities regulation.

The empirical results of this study indicate that measures to regulate the wealth effects in the stock market, represented by adjustment of liquidity regulation policy, will increase market volatility (Hypothesis 2). In excessive market volatility, there is a phenomenon of overreaction that is weaker than weak-form efficiency (Hypothesis 3). In the empirical analysis of the hypothesis "market volatility increases during the period of adjustments of liquidity regulation policy," this study uses two events as background: the Shanghai-Hong Kong Stock Connect and adjustments of liquidity regulation policy in the A-share market from 2014 to 2016, targeting the return rate of AH twin portfolio, assuming that the twin shares are subject to the Law of One Price. It uses the variance of return rate to represent volatility. Through comparative analysis of variance of return rate, two situations are observed during the period when policy for A-share exerts influences: first, the volatility of A-share index, twin A-share portfolio, and twin A-share sub-portfolio is higher during the period when the policy functions than that during the period when the policy is formed; second, the volatility of A-share index, twin A-share portfolio and twin A-share sub-portfolio is higher than the corresponding H-share index, twin H-share portfolio, and twin H-share sub-portfolio during the same period. In the empirical analysis of the hypothesis that during the period when A-share liquidity regulation policies are adjusted, the policy adjustments can cause changes in market valuation logic and liquidity, which will trigger overreaction or momentum effects in A share market, this dissertation uses the aforementioned two events as the background, targets the weighted average cumulative abnormal return (WACAR) of winner-loser portfolios of twin AH stocks, measures and cross-validates them with single-factor and three-factor models. Under the classic judgment mode of overreaction, the study reveals the presence of overreaction effect in the A-share market during the period of liquidity policy adjustment through data analysis, data testing, and graphical representation. The two findings provide insights into the issues to be considered in regulatory policy adjustment.

The contributions of this study can be summarized as follows: it represents a new attempt in policy research by revealing the motives of securities regulation and the specific outcomes of the regulatory practices through the overreaction in market; it enriches the perspectives of empirical study on Chinese securities regulation by confirming its objective of increasing the DFR with review and empirical approach; it remedies the defects of previous related studies by dividing window periods based on event backgrounds, thus avoiding paradoxical results caused by selection of different window periods and comparisons between different types of markets; it improves the quality of data cleaning and the reliability of conclusions with verification of ex-right factors, unifying trading days across different markets, and assigning values, thereby providing a more robust research paradigm for empirical analysis targeting securities pricing; it deepens the thinking of using winner -loser portfolios as a tool to identify market abnormal performances by considering winner-loser portfolios of AH twin shares as mutual condition for robustness test; it contributes a viewpoint to the mechanism of overreaction by regarding regulators as price deciders, thus explaining that market overreactions are the result of information diffusion among informed investors; and based on the research results, this study provides policy recommendations that securities regulators should exercise caution, professionalism, and openness before promulgating and during implementing policies that may affect stock market volatility so as to prevent behavioral failures from amplifying market failure.

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