The Drivers of the Great Bull Stock Market of 2015 in China: Evidence and Policy Implications

Abstract

This paper investigates what drove the great bull stock market of 2015 in China being called China’s 1929. Multiple regression models based on the Arbitrage Pricing Theory (APT) theory are developed to describe the variation in the stock return using economic fundamentals. The results indicate that during the normal period, the Chinese stock market is sensitive to economic conditions. However, the fundamentals cannot justify the variation in the stock return during the bull markets. The paper finds that during the bull market from May 2014 to June 2015, margin trading was the main driver of stock prices. And the actual stock returns during the bull period are significantly different from the conditional predictions based on the multiple regression model which is robust for the normal period. These results suggest that there is a speculative bubble in the bull market of 2015 in China. As commercial banks are becoming more exposed to the stock market, the volatility of stock prices may have the potential to increase the risk of the financial system and limit the freedom of monetary policy to deal with economic fundamentals. Therefore, it is important for China to stop margin trading and commercial banks’ financing for investment in the stock market to prevent a similar bubble from occurring again in the future.