Our study measures the impact of institutional reforms in China on market liquidity. Using monthly data on turnover ratios, turnover–volatility ratios and stock returns for the Shanghai and Shenzhen Stock Exchange and applying an intervention model, we detect a considerable impact of regulatory changes on liquidity. Motivated by the inventory paradigm and the disposition effect, our empirical model accounts for market returns and macroeconomic shocks. The ban of futures trading reduced market liquidity; however, lower commissions enhanced trading. Market reforms were favorable for the development of financial markets—but these effects were not long lasting.
We are grateful for the comments of an anonymous referee. Furthermore, we thank the discussants and participants of the annual meeting of the Midwest Finance Association in Milwaukee 2005 and of the First Chinese Finance Annual Conference in Xiamen 2004 for their helpful suggestions.
- Disposition effect