The China security market started in the early 1990s. The Shanghai Stock Exchange was established in December 1990 and the Shenzhen Stock Exchange was established in the following year. In the A-shares market, shares are traded and exchanged with Renminbi currency in both Shanghai and Shenzhen stock exchanges. To help domestic firms not only to raise funds from abroad, but also to reduce the negative impacts of the foreign capital on the immature China security market, in 1992, China’s Securities Regulatory Commission set-up the officially domestically listed foreign investment Shares (also called B shares). In the B shares market, shares are traded in foreign currencies on both stock exchanges. Until now, two types of shares are traded on the two mainland Chinese stock exchanges in mainland China.
Both A-shares and B-shares have distinct features. Firstly, the face value of A-shares is set in Renminbi; A-shares are traded in Renminbi as well. Secondly, only domestic citizens are allowed to trade A-shares, which means the price movement of A-shares can adequately reflect the behaviours of relatively immature investors in an emerging market. Also, it is one of the main distinctions between the China A-shares market and the stock market of any other developed country. Statistically, retail investors dominate in the A-shares market. According to the Shanghai Stock Exchange Statistics Annual (2016), the trading volume of retail investors constitutes 86.91% of the whole trading volume in 2015. Finally, there is no tax on capital gains from stock investments in the China A-shares market. As such, tax issues will not complicate our analysis.
On the other hand, B shares are utterly different from A-shares. First of all, the face value of B shares is set in Renminbi. In the Shanghai Stock Exchange, B shares are traded in US dollar, whereas in Shenzhen stock exchange they are traded in the Hong Kong dollar. Moreover, B shares are limited to foreign investment to some extent, even though the China Securities Regulatory Commission has begun permitting the exchange of B shares via the secondary market to domestic citizens since 19 February 2001, which means that its exchange is a mixture of transaction behaviours of domestic individual investors and that of foreign investors. Thus, it is hard to distinguish the effect of immature investors like domestic individual investors from that of mature investors like foreign investors. Eventually, all investors investing in B share companies need to pay taxes on capital gains from stock investments, except for the overseas individual investors investing in B share companies with foreign investment. Therefore, in comparison with the B shares market, we can find that the A-shares market has two significant characteristics, which are the reason for this paper to incorporate A-shares. That is, firstly, retail investors dominate the A-shares market. Secondly, there is no tax on capital gains from stock investments in the A-shares market.
Literature Review
The role of media in capital markets has been a topical issue in finance literature in recent years. Besides investigating the role of media in corporate governance [
7,
8,
9], another key research direction focuses on the effect of media on asset pricing. One of the earliest research in this direction is Niederhoffer [
10], who tests the stock market reaction to the world events reported in New York Times and finds that world events exert a discernible influence on the movements of the stock market averages. Klibanoff et al. [
11] tested whether exciting country-specific news in the front page of the New York Times affects the response of closed-end country fund prices to asset value. They found that in weeks of the news appearing on the front page of New York Times, prices reacted much more to the asset value, and the elasticity of price concerning asset value is closer to one, which is consistent with the hypothesis that news events lead some investors to react more quickly. Huberman and Regev [
12] conducted a case study on EntreMed and found that a New York Times article on the potential development of new cancer-curing drugs attracted enthusiastic public attention which caused a permanent rise in EntreMed’s stock price, even though no genuinely new information had been presented. Chan [
13] analyzed differences in stock price reactions after large absolute returns in the previous month depending on whether the underlying company was mentioned in a headline or lead paragraph. He found evidence of a steady drift without a reversal after bad news, which he interpreted as evidence of slow information diffusion. Veldkamp [
14] found that asset market movements generate news and news raises prices as well as price dispersion. Tetlock [
15] quantitatively measured the interactions between the media and the stock market using daily content from a famous Wall Street Journal column. He finds that high media pessimism predicts downward pressure on market prices followed by a reversion to fundamentals. Furthermore, Tetlock et al. [
16] discovered that the fraction of negative words in firm-specific news stories forecasts low firm earnings and stock returns. Earnings and return predictability from negative words are most significant for the stories that focus on fundamentals. The findings suggest that linguistic media content captures otherwise hard-to-quantify aspects of firms’ fundamentals, which investors quickly incorporated into stock prices.
As one of the most representative research among the numerous studies in the literature on the effect of media on asset pricing, Fang and Peress [
3] first investigated the cross-sectional relation between media coverage and expected stock returns. They explored that stocks with no media coverage earn higher returns than stocks with high media coverage, even after adjusting for well-known risk factors. They further argue that this cross sectional media effect is consistent with the “investor recognition hypothesis” advanced by Merton [
4], positing that stocks with lower investor recognition need to offer higher returns to compensate their holders for being imperfectly diversified and riskier. By disseminating information to a wide audience, media coverage broadens investor recognition. Thus, stocks with intense media coverage earn a lower return than stocks in oblivion. Following Fang and Peress [
3], Peress [
17] further investigated news media’s causal impact on trading and price formation by examining national newspaper strikes in several countries, and concludes that the media contributes to the efficiency of the stock market by improving the dissemination of information among investors and its incorporation into stock prices. Ahmad et al. [
18] found a negative relationship between media expressed negative tone and stock returns, which is very similar as that between media coverage and stock returns found by Fang and Peress [
3]. They further confirm that the general media is significantly biased towards negative news stories, and this biasness cannot be traced to newswires or news releases by the firm in the form of 8-Ks. It follows that the news media is more likely to pick up and run with bad news stories. Thereby, they argue that the count of media articles might be a proxy for negative tone, which provides an alternative explanation for the finding of Fang and Peress [
3], that high media coverage stocks underperform low or no coverage stocks.
The implicit assumption in Fang and Peress [
3] is that investors can rationally analyze the investment targets’ risk and return based on the information they obtain, and then make optimal investment decision according to the trade-off between risk and return. Media reports on the stocks can provide more information, reduce the investors’ risk of recognition and thus lead to a decline in their required rate of return.
However, the “attention-driven buying” theory represented by Barber and Odean [
5] argues that it is often difficult for investors to make a fully rational choice from a large number of stocks based on the trade-off between risk and return. Instead, investors have limited attention, and they are more inclined to select the stocks that have caught their attention. Media coverage on a stock will increase the investors’ attention and drive up its price. A bunch of previous studies has provided empirical evidence for the “attention-driven” theory. For example, Cook et al. [
19] found that investment banks have incentives to make use of news media to influence investors’ sentiment and drive new investors to buy new shares, increasing IPO pricing. Solomon et al. [
20] showed that media coverage of mutual fund holdings affects how investors assign money across funds. Fund holdings with high past returns attract extra flows; but only if these stocks are just featured in the media. The contemporary evidence that media coverage tends to contribute to investors’ chasing of past returns rather than facilitate the processing of useful information in fund portfolios, suggesting that media coverage can exacerbate investor biases instead of reducing them. Hillert, Jacobs, and Müller [
6] also advocated that media coverage can exacerbate investor biases. They found that firms with higher media coverage exhibit significantly stronger stock return momentum, suggesting the “attention-driven effect” of media coverage could persist. Using inclusive data on media coverage and merger negotiations, Ahern and Sosyura [
21] found that acquirers in stock mergers instigate substantially more news stories after the start of merger negotiations, but before the public announcement. This strategy generates a temporary run-up in bidders’ stock prices during the period when the stock exchange ratio is determined, which substantially affects the takeover price. Their findings implicate that firms have an incentive to manage the attention effect of media coverage to influence their stock prices during important corporate events.
From the above brief review of the literature, we can conclude that previous studies have reached a consensus that media coverage plays a vital role in the movements of stock prices, but they diverge in the direction and mechanism about how media coverage affects stock returns. Notably, there are significant differences between literature supporting the “risk compensation theory” represented by Fang and Peress [
3] and literature supporting the “attention-driven buying” theory represented by Barber and Odean [
5]. Existing literature has provided evidence for both theories, but it is hard to answer which theory prevails because the answer may vary with market characteristics. As a result, the negative relationship between media coverage and stock returns found in developed stock markets like the US might not necessarily hold in an emerging stock market like China. The main objective of this paper is thus to reexamine the relationship between media coverage and stock returns in China’s emerging stock market and testify whether the “risk compensation theory” or the “attention-driven buying” theory prevails in this market dominated by individual investors and by immature investors.