We construct size and value factors in China. The size factor excludes the smallest 30% of firms, which are companies valued significantly as potential shells in reverse mergers that circumvent tight IPO constraints. The value factor is based on the earnings-price ratio, which subsumes the book-to-market ratio in capturing all Chinese value effects. Our three-factor model strongly dominates a model formed by just replicating the Fama and French (1993) procedure in China. Unlike that model, which leaves a 17% annual alpha on the earnings-price factor, our model explains most reported Chinese anomalies, including profitability and volatility anomalies.

We perform transaction-level analyses of entrusted loans, one of the largest components of shadow banking in China. Entrusted loans involve firms with privileged access to cheap capital channeling funds to less privileged firms, and the increase when credit is tight. Nonaffiliated loans have much higher interest rates than both affiliated loans and official bank loans, and they largely flow into real estate. The pricing of entrusted loans, especially of nonaffiliated loans, incorporates fundamental and informational risks. Stock market reactions suggest that both affiliated and nonaffiliated loans are fairly compensated investments.