Does Noise Trader Risk Repel Arbitrageurs? Evidence from Chinese A-H Share Premia

Abstract: What causes the Chinese A-H share premia puzzle? A-shares enjoy a premium over corresponding H-shares on average by 125%, despite the same rights and dividends. The existing hypotheses such as differential risk, differential demand, liquidity, and asymmetric information cannot successfully account for the great magnitude of inflated A-share prices and are also inconsistent with our sample from 2014-2019. In this paper, we propose and empirically test a simple new explanation of A-H premia based on the combination of noise trader risk and the limits to arbitrage. We argue that arbitrageurs avoid correcting mispricing because of expected future price volatilities driven by investor sentiment. Our methodology can explain for the magnitude of A-H premia as well as the evolution of A-H premia using empirical proxies for noise trader risk.