Since 1973, the original Black and Scholes Option Pricing Model has been the subject of much attention. Many financial scholars have expanded upon the original work. In 1973, Robert Merton relaxed the assumption of no dividends. In 1976, Jonathan Ingerson went one step further and relaxed the assumption of no taxes or transaction costs. In 1976, Merton responded by removing the restriction of constant interest rates. The results of all of this attention, that originated in the autumn of 1969, are alarmingly accurate valuation models for stock options.
Background of China Financial Market History Introduction In the first half of the 20th Century, China was one of the hottest emerging markets for global investment. One estimate of total foreign capital invested in China in 1938 put it at $2. 5 billion, third behind India and Argentina as a target of developing market investment, and not dramatically less than the $7 billion of foreign investment in the United States at the time. Active foreign investment in China, of course, has a much longer history.
It began in the mid-Qing era, with direct investment by Britain and other European countries, and developed by the late-Qing into a quasi-colonial relationship with effective foreign control of China’s largest commercial port cities. Over the period 1870 to 1930, the Chinese financial system underwent extraordinary change. Chinese enterprise in major port cities developed from family-based, private equity ventures and quasi-public firms, to publicly-held corporations which could tap both domestic and foreign savings through both international and domestic stock and bond markets.
Chinese government borrowing began in the late 19th century as an informal process of financial demands levied upon wealthy citizen in times of need. By 1930, despite having defaulted on and restructured significant parts of her debt, China was able to issue bonds for major infrastructure projects on the leading exchanges of the world. In addition, an active domestic bond market provided funding for the nearly ceaseless internal and external military struggles that lasted from the fall of the Qing in 1912 to the revolution that created the current government in 1949.
What makes Chinese finance during this transition era particularly interesting is not the speed and progress of development so much as the problems encountered along the way. Despite the eventual success of capital markets in Shanghai and other coastal cities by mid-century, Chinese finance lagged far behind developments in Europe and Japan during this transition period. Chinese officials in the late Qing tried to remedy the imbalance through regulatory reform, these remedies in most cases, were largely ineffectual.
Despite experimentation in the late 19th and early 20th centuries with domestic joint-stock companies, China relied primarily on foreign investment through the end of the Qing dynasty. The legacy of this reliance is still visible today. Foreign investment over the period 1870 to 1930 financed remarkable growth in the Chinese economy; however it came at a price – the most visible of being preferential government concessions to foreign investors, and partial foreign control over government finances.
From the foreign perspective, these concessions were simply investor protections. From the Chinese perspective, however, these terms were viewed as an affront to Chinese sovereignty and an impediment to the development of a domestic corporate sector. As a consequence, the terms of Chinese external investments contributed to a backlash against foreign ownership of Chinese capital and foreign encroachment on Chinese sovereignty.
Although a vigorous capitalist system grew in cities like Shanghai in the late 1920’s and 1930’s, the seeds of resentment towards foreign capital became a popular catalyst for the Leninist revolution in 1949, an event that shifted China away from widespread economic and financial relationships with large sectors of the developed world. Only in the last two decades has China returned to the global financial community and in the last decade China has begun to rebuild her own domestic capital market. Equity Market Development
In contrast to Europe, the United States and Japan, China’s capital market development in the late 19th century was modest. The domestic investor opportunity set was relatively small, geographically limited, and suffered from early turbulence that might have dissuaded more widespread investment. Never-the-less, the path of the development of the equity and debt markets in China suggests some reasons for the discrepancy, and also makes clear that proposals and potential for development existed relatively early. The original impetus for tapping Chinese investor capital for development came in part from a Chinese scholar who studied overseas.
Yung Wing, a famous reformer and graduate of Yale College in 1854, proposed the joint-stock financing of a Chinese steamship transportation company to the governor of Kiansu province in 1867. His plan was approved, but it was not until 1872 that Shanghai entrepreneur Sheng Hsun-Huai (??? ) founded the China Merchant’s Steamship Navigation Company as a joint-stock company to compete with foreign operated maritime transportation lines. The company was essentially quasi-private. Local merchants were induced by the provincial government to own shares and to manage the firm, and the government provided a loan that was eventually forgiven.
The company was operated with the joint goal of generating profits for shareholders and providing a domestic rival to foreign-owned shipping firms. Other Chinese joint-stock companies were formed 1870’s by Sheng and other entrepreneurs in the 1870’s and 80’s under the auspices of the Kuan-tu Shang-pan (???? ) system – “Official Supervision and Merchant Management. ” The shares of these ventures, including the Imperial Telegraph Administration, the Hua-sheng Textile Mill in Shanghai and the Imperial Bank of China, were sold primarily to wealthy merchants and were subject to virtually no official securities laws.
Shares in Kuan-tu Shang-pan ventures were occasionally traded, and prices for most of the 1880’s were printed in Chinese language newspapers in Shanghai, however there was not official exchange for Chinese securities during this stage. China’s first domestic stock price boom dates to the 1880’s when the list of publicly traded firms nearly tripled from 10 to 29, and stock prices nearly doubled by 1882, feeding investor speculative demand. Unfortunately, the Shanghai market crashed in mid-1880’s, reducing the traded list to 12 and dropping share prices to roughly half book value.
This early bubble may have had a long term influence on investor appetite for shares. Meanwhile, Figure 1 on next page shows that the stock prices of foreign invested companies stayed largely stable, indicating that domestic and foreign equity markets are quite separated at that time in China. Following the crash, prices were no longer recorded in local newspapers — the crash of the 1880’s seems to have dampened investor enthusiasm for shares for nearly two decades. China’s first stock exchange, the Shanghai Share Broker’s Association, was founded in 1891 in Shanghai by foreign businessmen.
Foreigners founded another stock exchange, the Shanghai Stock Exchange, in 1904, which later merged into Shanghai Share Broker Association. These exchanges were initially only for traded shares of foreign companies and foreign investment projects. While they facilitated international portfolio diversification, it is not clear the extent to which these foreigner-founded exchanges served the needs and interests of Chinese investors. Only members could trade in the Shanghai Share Broker Association (SSBA) and out of the 100 members of SSBA, about 10 members were Chinese.
Like other well-known restrictions by the foreign merchants on Chinese access to institutions, until 1935, Chinese were constrained from trading through SSBA. Trading in domestic shares thus took place apart from the leading exchanges and in all likelihood remained relatively small around the turn of the century. The number of domestic listings reaching a maximum of 37 in the late Qing era, and investors were geographically limited to the vicinity of Shanghai and transactions were infrequent.
By 1935, the Shanghai China Merchants Stock Exchange had grown to become one of the biggest exchanges in the Far East with a list of 190 companies and an annual trading volume from 2 to 5 trillion Yuan. Interestingly, the Shanghai China Merchants Stock Exchange itself was a public company listed on the Exchange. Shanghai was then one of the most important capital markets in Asia, with a strong domestic and international banking sector and a vigorous market for domestic and foreign stocks and bonds.
This had not been the case three decades earlier, when thoughtful attempts to develop home-grown Chinese capitalism experienced sporadic successes and failures that limited the ability of domestic investors to hold diversified portfolios. The early lack of functional capital markets likewise limited the ability of Chinese commercial enterprises to access significant capital. While foreigner-controlled exchanges functioned relatively earlier than Chinese-controlled exchanges, even they could not be compared to the scale and scope of European markets, or to contemporaneous capital markets in Japan.
Beyond capital constraints on enterprise, the lagging development affected domestic Chinese investors by leaving them relatively undiversified when compared to foreign investors who accessed more fully-developed markets. Modern market China’s modern securities market took off after the early 1990s when exchanges were established in Shanghai and Shenzhen. During most of the 1990s, the dominant philosophy was that securities markets are supposed to serve large state-owned enterprises (SOEs). As a result, most companies listed on exchanges in China are SOEs.
Moreover, the state owns more than fifty percent of the shares of these enterprises and these shares are not tradable. Since the late 1990s, however, more and more private companies have entered the securities market. As of the end of April 2001 private firms or individuals controlled 10. 5 percent of the companies listed on the Shanghai and Shenzhen exchanges. The modern securities market in China has a very brief history. Some enterprises issued stocks and bonds to obtain funds for business expansion in the late 1980s, but these issues were odd and irregular and there was no legal market for secondary trading.
Then the modern securities market began with the launching of exchanges in Shanghai and Shenzhen in 1990. Since then, the securities market has played an increasing role in the financing of enterprises in China, with stocks the main instrument traded in the securities market. For the eleven years from 1991 through 2001 China’s enterprises raised a total of 7772. 7 billion RMB yuan on the two markets through IPOs, additional flotation by listed companies, and convertible bond issues by listed and non-listed companies. Since 1997 enterprises raised between 84. 2 billion and 210.
4 billion RMB yuan a year in the securities markets. The number of enterprises listed on the Shanghai and Shenzhen exchanges increase rapidly, from only 10 in 1990 to 1,153 at the end of 2001. The number of registered stockholders reached about 65 million in 2001. Market value also increased enormously. The total capitalization of the Shanghai and Shenzhen markets rose from 35. 3 billion RMB yuan in 1993 to 4,376. 3 billion at the end of 2001. Securities market capitalization exceeded fifty percent of GDP for the first time in 2000, and China’s stock market is now the second largest in Asia after Japan’s.
With the adoption of corporatisation or ‘modern enterprise system’ policy in 1995 many SOEs were reorganized into shareholding corporations and in consequence the majority of companies listed on China’s stock exchanges are SOEs. Most companies that transformed from pure state-ownership to shareholding enterprises have three types of shares, state shares which are non-negotiable (that is, they cannot be sold in the market), shares held by employees, and shares held by legal entities including other companies and financial institutions.
Usually, the non-negotiable state shares comprise the majority of a listed company’s shares, and thus the state retains control of these listed enterprises. During most of the 1990s, regulators and government and enterprise officials viewed the securities market mainly as an instrument to serve SOEs and even to rescue them from financial difficulty. Since the late 1990s, though, the situation has changed. More and more listed companies have been restructured with private companies purchasing their shares and becoming controlling shareholders.
Furthermore, the underlying philosophy changed since the China Securities Regulatory Commission (CSRC) was reorganized in 1998 and the Securities Law took effect in 1999. The examination and approval system and quota systems for issuing securities, which tended to favour SOEs and give government agencies a large say, were replace. Under the new verification system for public offerings, private companies, have more equal access with SOEs to funding from the securities market.
More private companies have been listed and the securities market is playing an increasing role in the development of private companies. BS Model’s Application in the World Market In the modern financial market throughout the world, a few popular options pricing models are applied, including Binomial model, GARCH, ARCH, and Black-Scholes Model. Amongst those models, BS is the most widely used one. Some countries which applies BS model are discussed as follow.