Institutional opening of capital market and stock price Bubble: Evidence from China

Abstract

Speculative behaviors by retail investors in China’s capital markets, such as herding behaviors (e.g., momentum trading and panic selling), have led to persistent stock price bubbles. These accumulated bubbles severely undermine the healthy development of the equity market. As a critical institutional reform for high-level capital market openness, the inclusion of A-shares in the MSCI Emerging Markets Index provides a quasi-natural experiment to examine the effects of opening policies. This study employs a difference-in-differences (DID) model to analyze the impact of MSCI inclusion on stock price bubbles and its underlying mechanisms. The findings reveal that inclusion in the MSCI Index significantly exacerbates the degree of stock price bubbles, a conclusion robust to alternative bubble metrics, extended sample periods, and placebo tests. The mechanism analysis demonstrates that MSCI inclusion intensifies bubble accumulation through elevating investor attention and enhancing stock liquidity. Specifically, index constituent stocks attract heightened media coverage and investor searches (proxied by the Baidu Search Index), improve stock liquidity, and amplify irrational trading behavior, driving stock prices to deviate from intrinsic values. Heterogeneity analysis further identifies information transparency and corporate governance as key moderating channels: The bubble-aggravating effect is concentrated in firms with lower information transparency and poorer corporate governance, as these firms are more vulnerable to investor sentiment fluctuations and the market’s failure to disclose negative information. This study contributes to the literature on financial risks associated with capital market liberalization, uncovers the formation pathways of such risks, and provides novel insights for policymakers to mitigate financial vulnerabilities, reduce stock price bubbles, and foster the high-quality development and further opening of China’s capital markets.