THE IMPACT OF POLICY CHANGES ON CHINESE STOCK MARKETS

Abstract

This study examines the effect of policy changes on stock market returns in China. China is a suitable platform for this study as it has introduced numerous policy changes in the course of shifting from a centrally planned economy to a market economy. Policy risk is defined as the incremental uncertainty of a firm’s cash flows due to frequent changes in regulations. In total, we observed 87 policy changes, out of which we categorized 20 as multiple-type policy changes and 62 as stock market related policy changes. On top of that, we group the policy changes into two time periods, 42 policy changes in the 1993-2004 period and 45 policy changes in the 2005-2009 period. We minimize the endogeneity problems through the use of market control variables and 11 firm level control variables. At the same time, we also keep the event windows short. We find negative announcement returns surrounding multiple-type and stock market related policy changes and positive announcement returns surrounding policy changes in general, non-multiple-type, non-stock market related, 1993-2004 period and 2005-2009 period policy changes. Multiple-type policy changes have lower returns than non-multiple-type policy changes. Stock market related policy changes have lower returns than non-stock market related policy changes. Policy changes in the 1993-2004 period have lower returns than those in the 2005-2009 period. We document that the presence of the state and regulated industries provide a “safety” effect. Thus state owned firms and regulated firms perform relatively better than non-state owned firms and unregulated firms respectively. We also observe that higher concentration of policy changes six months prior to the event date carries higher policy risk for policy changes in general, non-multiple-type, stock market related and 2005-2009 period policy changes.