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| The Impact of T+1 Trading Mechanism on China's Stock Market——New Evidence Based on Implied Option Values |
| ZHU Hongbing, ZHANG Bing
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School of Business, Hohai University;
School of Business, Nanjing University |
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Abstract As the world's largest emerging market, China's stock market exhibits distinctive local characteristics with the T+1 trading mechanism as one of the prime example. First introduced in 1995, T+1 became a unique foundational system in China's stock market, standing apart from the mainstream global markets and representing a localized exploration of capital market infrastructure. It was originally designed to curtail rampant speculation in the market's early stages and maintain orderly trading. By restricting same-day sell orders by buyers, it lowered intraday trading frequency, effectively dampening speculative enthusiasm in early days. However, as the market matured and integrated more with the world, the limitations of T+1 have become increasingly apparent. Theoretically, T+1 can “cool down” the market by lowering trading frequency. But in a market with strong heterogeneity of beliefs, such external restrictions may exacerbate volatility and fuel speculation. In China's stock market, investors often hold widely divergent views and the market is flush with liquidity, so T+1 may have actually spurred speculative trading. Meanwhile, it prevents buyers from correcting mistakes in time, disadvantaging small and medium-sized investors. Furthermore, it heightens asymmetries of rights between investors in index futures and the spot market.
In recent years, the call for market reforms has grown more urgent. Ahead of the launch of the STAR Market (Sci-Tech Innovation Board) in 2019, whether to adopt T+0 or T+1 became a heated topic. In March 2021, the China Securities Regulatory Commission stated that T+0 trading involves numerous stakeholders and would have profound market impacts, thus requiring careful planning and thorough evaluation. While T+1 did play a positive role in the market's early stages, its suitability has been widely questioned amid demands for high-quality development in the capital market. However, China's capital market has operated under T+1 for so long that there is little comparative data under alternative settlement mechanisms, making it difficult for academic researchers to empirically evaluate its effects. Consequently, constructing a theoretical price model tailored to the Chinese context and quantifying the influence of T+1 have become key scholarly and practical challenges.
Against this backdrop, this paper introduces an implied put option framework that captures liquidity discounts embedded in stock pricing, splitting the stock price into its fundamental value and option value. Theoretically, we demonstrate the relationship between T+1 trading and overnight returns, and we empirically verify these findings using data from the Shanghai and Shenzhen A-share markets. We then further examine how arbitrage constraints moderate this relationship and use high-frequency index data to investigate the intraday decaying effect of the discount induced by T+1. Lastly, employing a Taylor expansion, we quantify the overnight return discount attributable to T+1. The results reveal: first, T+1 entails considerable institutional costs, distorts both intraday and overnight return distributions, and contributes to persistently negative overnight returns in China's stock market—with an estimated annual discount of 12.11% caused by T+1. Second, under T+1, stock prices reflect not only a company's fundamentals but also option-like liquidity discounts. Factors affecting this option value directly influence overnight returns: higher opening prices, greater historical volatility, and larger deviations between two consecutive days' opening prices tend to produce more negative overnight returns; meanwhile, a higher risk-free rate raises overnight returns. Arbitrage constraints amplify these negative relationships. Third, the option component embedded in the stock price peaks at the market open and then gradually decays throughout the trading day, leading, over the long run, to relatively lower open prices and higher close prices, and thus more negative overnight returns. High-frequency data show that T+1 increases trading volume at the open but does not lift overnight returns; in fact, it exacerbates negative returns. This reflects predominantly sell-side activity at the opening and suggests that T+1 amplifies investors' willingness to sell at the open.
From both theoretical and empirical perspectives, this paper enriches the study of China's distinct financial system by analyzing how market mechanisms shape asset pricing, and it offers valuable practical insights for refining the country's stock market infrastructure. Specifically, this study illustrates how T+1 imposes asymmetric trading constraints that spur opening-hour sell pressure, skewing intraday supply-demand dynamics and creating a buyer's market for much of the trading session. Considering financial stability, replacing T+1 with T+0 in the short term is challenging. Instead, its negative effects can be mitigated by complementary measures that rebalance supply and demand. For instance, exchanges could introduce flexible single-stock options, providing investors with additional hedging tools.
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Received: 11 March 2024
Published: 01 February 2025
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