Chinese shares have reached a dangerously high level because the market is failing to price risks properly, just as investors misjudged the value of U.S. subprime mortgages, an academic economist said on Thursday.

Xu Xiaonian, a professor of economics and finance at China Europe International Business School in Shanghai, blamed government interference for muffling price signals and said Beijing should leave the field to market forces.

The mispricing is due to the misfunctioning of the government, said Xu, a former managing director and research head of China International Capital Corp, an investment bank.

The subprime crisis also happened because the market didn't know how to price the product, he told a forum.

The benchmark Shanghai stock index (.SSEC: Quote, Profile, Research) ended up 1.95 percent on Thursday. It has more than doubled this year and more than quadrupled since the start of 1996.

Xu said the main risk in China's financial system had shifted from once-wobbly banks to the stock market, where valuations were now at a dangerous level.

Stock market bulls cite fast-rising corporate profits as a justification for China's lofty valuations.

But many domestic investors also say they are betting that Beijing will not let the stock market fall in the run-up to October's five-yearly congress of the ruling Communist Party and next August's Olympic Games.

Investors are rational, Xu said. In their eyes, the only risks are to do with government policy.

In the event of a drastic market correction, the social fallout would be more significant than the impact on economic growth or the banking sector, Xu said.

Beijing, ever fearful of the threat to social stability, is worried about millions of novice investors who have jumped onto the stock market bandwagon.

But Xu said the government should leave the market to its own devices and abandon unnecessary controls. The central government, for instance, strictly regulates public stock offerings and the launch of mutual funds.

Ted Tokuchi, head of investment banking with CITIC Securities, said Chinese stock prices would not collapse. But he said the market's price-earnings ratio of more than 50 was now much higher than what he considered to be a rational range of 30-40.

Although he remained optimistic about the long-term outlook, Tokuchi said a correction was necessary in the short term.

He said the main risks to the market were an external economic shock or a sharp rise in domestic interest rate rises due to high inflation.

Price indicators such as CPI are rising very fast and the government right now is acting a bit slow, Tokuchi said.

Consumer price inflation jumped to a decade-high of 6.5 percent in the year to August from 5.6 percent in July.

If the situation continues, China will need to raise interest rates at least 3 percent more, Tokuchi said.

China has already raised interest rates four times this year. But the one-year commercial bank deposit rate of 3.6 percent is still well below the inflation rate.

China Inflation