The Effect of the China Connect

Abstract

Stock market liberalization generates benefits and costs. We estimate these effects using the Shanghai (Shenzhen) - Hong Kong Stock Connect, an important opening that allows foreign investors to trade a subset of mainland Chinese firms. The liberalization brought connected Chinese firms lower funding costs and more investment, but also increased sensitivity to foreign shocks. These effects are stronger for firms whose stock return has a higher covariance with the world market return and for firms relying more on external financing. We find that both (greater) risk sharing and (lower) funding cost channels explain our results.

Keywords: Capital Account Liberalization; Capital Controls; Global Financial Cycle; Foreign Spillovers; China Connect; Corporate Investment

JEL Classification: F38; E40; E52; G15