RESEARCH PAPER

An Empirical Study of Pricing Efficiency and Arbitrage Opportunity in Hong Kong Stock Index

ABSTRACT

This paper examines the short run and long run performance of the top 49 stocks of Hong Kong. This trend will enable us to understand the arbitrage pricing theory prevailing in Hong Kong stock market. We have taken the data of 49 stocks of Hong Kong stock market. The data has been gathered from 1999 to 2006. The trend analysis has been implemented to know the performance of short and long run of the stock exchange. Several macroeconomic variables used in this study are derived from financial theory. For example, it is known that the stock price of a company is determined not only by the company's future cash flows but also by the discount rate. Macroeconomic variables that affect stock prices through future cash flows or the discount rate include: (1) the growth rate in industrial production, (2) inflation, (3) unanticipated changes in risk premia, and (4) foreign trade.

ABSTRACT2

CHAPTER 1: INTRODUCTION5

1.1 Background of the Study5

1.2 Aims and objectives of the Study6

1.3 Rationale of the Study6

1.4 Limitation of the study7

1.5 Significance of the study8

CHAPTER 2: LITERAURE REVIEW9

2.1 Hong Kong: A Capital Market with Chinese Characteristics13

2.2 Institutional features of the Stock Exchange of Hong Kong (SEHK)16

2.2.1 Trading mechanism16

2.2.2 Information on the screen17

2.4 Factors affecting price elasticity estimates of the limit order book19

CHAPTER 3: DATA AND METHODOLOGY23

3.1 Sample and data description23

3.2 Methodology25

CHAPTER 4: EMPIRICAL RESULTS AND ANALYSES27

4.1 Performance of weekly extreme stocks27

4.2 Analysis of market sentiment29

4.3 Analysis of interdependence30

4.4 Analysis of stock characteristics32

CHAPTER 5: CONCLUSIONS35

References36

Appendix I44

Appendix II47

An Empirical Study of Pricing Efficiency and Arbitrage Opportunity in Hong Kong Stock Index

CHAPTER 1: INTRODUCTION

1.1 Background of the Study

In accordance with a series of five-year economic plans beginning in 1962, the Hong Kong economy has recorded a relatively high average growth rate of 8.5% per annum during the last two decades. In 1987, the gross national product (GNP) was equivalent to US$119 billion, and per capita GNP was US$2,826.2 During the same year, exports totaled US$47.1 billion, which was 35.7% above the 1986 level; imports also rose by 29.8% to US$41.0 billion. The Hong Kong economy has grown at one of the fastest rates in the world during the past several years. The Hong Kong securities market has kept pace with this rapid economic expansion over the past several years, as measured by trading volume and stock prices. Total capitalization of the stock market at the end of 1987 was US$33.1 billion, equivalent to about 27% of the Hong Kong GNP. The face value of all bonds outstanding was US$37.1 billion (Burmeister, 1986).

These amounts are not large in comparison to the Japanese, American, and British markets. However, Hong Kong will have the second largest stock market in Asia and Oceania within a few years if the present trend continues. The rapid growth of the Hong Kong securities market has made it an attractive profit center to foreign investors. Banks were the most important domestic corporate funding sources in Hong Kong until ...