Effect of ETF Connect on the Hong Kong and Mainland Stock Markets

ETFs are exchange-traded products that seek to replicate an underlying index. The global ETF market has experienced exceptional growth in the last 20 years. In China, there is also great demand for ETF products, and the country has now overtaken Japan as Asia’s largest ETF market. The popularity of ETFs arises from the advantages they provide in terms of diversification, transparency, cost-effectiveness, and trading convenience. However, some studies also show that ETFs may harm the market quality of constituent stocks. This project will study the effect of the launch of ETF Connect, implemented in 2022. The ETF Connect scheme allows Mainland investors to access Hong Kong-listed ETFs (Southbound trading) and Hong Kong investors to invest in Mainland-listed ETFs (Northbound trading). I will investigate the effect of the launch of ETF Connect on constituent stocks. I propose to examine how trading activities under ETF Connect will affect the liquidity and volatility of constituent stocks, the pricing efficiency of the ETF, and whether the flows under ETF Connect will have any return predictability. The analysis will be performed for both southbound ETF trading (from Mainland investors) and northbound ETF trading (from Hong Kong investors). This project will make an important contribution to the academic literature. While existing literature has extensively studied the effects of ETFs on domestic markets, this study will deepen our understanding of how ETFs function as conduits of financial integration between Hong Kong and Mainland China. This research will provide empirical evidence to help policymakers and regulators assess whether ETF Connect improves liquidity, market efficiency, and stability, supporting the evaluation of the scheme’s effectiveness.