Abstract: Macro factors have played an important role in explaining the A share and H share price differences of cross-listed companies (AH premium), especially the surge of the AH premium index after 2015. Over the period of 2007 and 2019, the impacts of USD index shocks dominate the overall changes of the AH premium on individual equity basis. Moreover, USD index can explain about 50-70% of the changes of the AH premium index, and the investors’ expectation of Chinese economy can add another 10% of the explanatory power. After the initiation of Shanghai-Hong Kong Stock Connect (SH Connect) in November 2014, the AH premium index jumped from 115.8 to 126.4, but with significant decline in its variance. If we segregate the impacts of USD index, the AH premium index average only increased 2.7 ppt from 98.8 to 101.5. Furthermore, after the initiation of SH Connect, the prices of cross-listed shares have been more responsive to exchange rate information. Over a longer-term, SH Connect may have reduced the impacts of USD index, while increased the impacts of effective prices on equity prices. The above findings demonstrate that hedging for foreign exchange risks is the main reason for investment in H shares of mainland firms, and as a result, enhancing RMB foreign exchange rate flexibility is the core component as well as pre-condition for financial market opening in China. Besides, when the market conditions permits, the policymakers and regulators should consider a pilot program allowing investors to arbitrage those shares with AH premium in a reasonable range. This may further reduce the AH premium, and enable the share prices convergence in the long-run.
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