Exogenous Noise or Endogenous Feedback? Exploring the Sources of Excess Comovement in an Emerging Stock Market

Abstract

We study the effect of country-specific noise on stock price comovement. Using a sample of dual-listed stocks, we show that the effect persists over time for some largest A-shares traded in China, but diminishes quickly for their H-shares traded in Hong Kong. We then examine whether the noise source of this cross-country difference can be traced to the aggregate demand shock of unsophisticated investors, as proxied by trading imbalance variables, or the feedback structure underlying the interactions between individual decisions, as proxied by trading interdependence variables. Our trade-based empirical tests confirm the predictions of the latter view. The results suggest that exogenous noise provides an incomplete basis for understanding emerging-market-specific price behavior, and may need to be expanded to allow for richer foundations based on endogenous feedback.