Time-varying risk premia and forecastable returns in futures markets

Abstract

This paper examines the effects of bi-directional cross-border equity flows on stock returns, volatility and valuation differential using the unique setting of Shanghai – Hong Kong Stock Connect program (Stock-Connect) in China. Via Stock-Connect, international investors from Hong Kong (mainland China) can trade qualified stocks listed in Shanghai (Hong Kong). We find that southbound (northbound) investors’ net purchases positively predict returns of connected Hong Kong (Shanghai) stocks. However, southbound and northbound equity flows have opposite effects on stock volatility: there is a positive (negative) relationship between lagged southbound (northbound) flow volume and volatility of connected stocks in Hong Kong (Shanghai). A higher price premium of A shares over H shares leads to an increase in Southbound net purchase, which in turn results in a lower AH share price premium. Our study shows that stock market integration facilitates information sharing and narrow valuation differential across previously segmented markets.