Abstract
How macroeconomic risk affects asset prices is an important issue in the academic and industrial fields. This paper measures Chinese financial stress (CFSI) by constructing a new index, and empirically verifies the pricing relationship between financial stress and Chinese mutual fund returns. First, we use eight source variables, which are the driving forces of financial market risk and financial stability, from bank, security, and foreign exchange markets, to build a new index representing financial stress. In addition, we estimate mutual funds’ exposure to financial stress and find that the resulting financial stress betas explain a significant proportion of the cross-sectional dispersion in mutual fund returns. Moreover, this result also remains robust when we conduct tests using other macroeconomic indices or control for the Fama–French and Carhart four factors. Hence, we argue that financial stress is a powerful determinant of cross-sectional differences in Chinese mutual fund returns and plays an important role in the sustainable development of financial markets.
Highlights
Based on the close relationship between macroeconomic and asset pricing, a hot issue in academic research is to use macroeconomic conditions to predict asset returns
Where Ri,t+1 represents the excess return of fund i in month t + 1; βiC,tFSI is the financial stress index beta for fund i in month t; SIZEi,t indicates the market value of fund i in month t; AGEi,t is measured as the number of months a fund has existed since its inception; ManagementFeei,t is percentage fee of assets under management, typically ranging from 1% to 2%; and CustodianFeei,t is the fee charged by custodians for the custody and disposal of a fund’s assets, which is usually measured in proportion to the net assets of the fund, and is usually approximately 0.25%
The time series regressions over the 36-month rolling window period are used to estimate the monthly beta of mutual fund exposures to the 1-month lagged financial stress index
Summary
Based on the close relationship between macroeconomic and asset pricing, a hot issue in academic research is to use macroeconomic conditions to predict asset returns. We first choose eight indicators from the bank, security, and foreign exchange markets to construct a new financial stress index; and we investigate whether mutual funds’ returns are associated with this financial stress proxy using Fama–MacBeth (Fama & MacBeth, 1973) cross-sectional regressions, namely, whether financial stress helps predict mutual funds’ future returns in China. In order to empirically test our hypothesis, we run the Fama–MacBeth cross-sectional regressions following Bali et al (2011, 2014), and we find that the cross-sectional relations between the Chinese mutual funds’ exposures to financial stress and their future returns are statistically positive and significant.
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