Chinese Equity Market Research Articles

Does equity market timing have a persistent impact on capital structure? Evidence from China

This paper uses the change in individual securities accounts as a measure of equity funding supply to examine whether the persistent timing effect on capital structure exists for the Chinese equity market. This new equity timing measure avoids previous criticisms over a timing measure not being independent of a firm's characteristics of capital structure. Our empirical results show that this new measure is an effective market timing variable for issuing equity in the Chinese equity market, and that a persistent effect of equity market timing on firm capital structure exists for more than 7 years. This paper offers evidence that the market conditions of equity funding supply play an important role in corporate financing decisions in China.

Characteristics-Based Portfolio Policy: Evidence from China

ABSTRACT This study demonstrates the superiority of a characteristics-based portfolio policy in the Chinese equity market and proposes a novel approach for selecting characteristics. This policy models portfolio weight as a function of firm characteristics and estimates weights by optimizing investor utility. The policy’s performance in China is remarkable: a basic portfolio based on size, book-to-market, momentum, profitability, and investment characteristics achieves a Sharpe ratio of 1.05. A selection method for characteristics is proposed based on the redundancy test of corresponding factors. Selecting characteristics before portfolio construction improves the Sharpe ratio (alpha) of the portfolio by 37.48% (22.17%).

Beware of the crash risk: Tail beta and the cross-section of stock returns in China

ABSTRACTWe investigate the pricing of systematic tail risk measured by tail beta in the Chinese equity market. Using an array of tests, we examine the performance of more than 3,300 stocks for the years 1999 through 2018. Contrary to evidence from developed markets, we demonstrate a strong negative relationship between the tail beta and future returns. The effect is robust to many considerations and cannot be explained by established pricing factors or alternative risk or illiquidity measures. We link our findings to specific characteristics of the Chinese stock market.

Information Content in International Equity Volatility on Yuan�s Depreciation

We investigate whether depreciation of USD-CNY exchange rate causes direct or indirect effects on conditional variances in the international equity markets, especially of Japanese, ASEAN, Australian, and Indian markets. Employing APARCH and using MSCI indices we find a significant positive impact of Yuan’s depreciation on the conditional variances of Japanese, ASEAN and Australian equity markets. When USD-CNY exchange rate depreciates by 0.25 percent or more, volatility in the Chinese equity market causes a significant positive impact on the conditional volatility in the Japanese and Australian equity markets, though with some lag. USD-CNY exchange rate movements strongly influence the ASEAN equity markets across all time frames. The findings may enable investors to manage their portfolios of equity markets under consideration in the presence or absence of USD-CNY movements.

Beware the Crash Risk: Tail Beta and the Cross-Section of Stock Returns in China

We investigate the pricing of systematic tail risk measured by tail beta in the Chinese equity market. Using an array of tests, we examine the performance of more than 3,300 stocks for the years 1999 through 2018. Contrary to evidence from developed markets, we demonstrate a strong negative relationship between the tail beta and future returns. The effect is robust to many considerations and cannot be explained by established pricing factors or alternative risk or illiquidity measures. We link our findings to specific characteristics of the Chinese stock market.

The transmission of US economic policy uncertainty shocks to Asian and global financial markets

This paper proposes a novel approach to investigating the spillover effects of US economic policy uncertainty shocks on the global financial markets. Employing a factor-augmented vector autoregression (FAVAR), we model US economic policy uncertainty jointly with the latent factors extracted from equity prices, exchange rates, and commodity prices. We find that US economic policy uncertainty affects these factors significantly. A country-level analysis shows heterogeneous responses to an increase in US economic policy uncertainty. With regard to equities, US economic policy uncertainty adversely affects equity prices. However, its impact on the Chinese equity market is relatively small. As for foreign exchange markets, while many currencies depreciate in response to an increase in US economic policy uncertainty, the US dollar and the Japanese yen appreciate, reflecting their safe-haven status. The Chinese yuan, whose nominal exchange rate is closely linked to the US dollar, also appreciates in response to uncertainty shocks.

The Effects of Environmental Disasters and Pollution Alerts on Chinese Equity Markets

ABSTRACT Environmental disasters not only cause severe losses in human lives and well-being but also affect economic and industrial activities, influencing firm performance and investors’ risk perceptions. We investigate the effects of 18 chemical disasters, oil spills, and pollution alerts on the Chinese stock market from 2003 to 2015. We find that these events generate significantly positive or negative returns, depending on the industry. Our results show no clear pattern suggesting that polluting industries are the most penalized; however, they indicate that environmental disasters create uncertainties in the market and often change investors’ risk perceptions in both the short and long term.

Residual momentum and the cross-section of stock returns: Chinese evidence

In this paper, I find that sorting stocks into portfolios based on their residual, as opposed to raw past returns, generates significant profits in the Chinese equity market and cannot be subsumed by the well-established factor models. Moreover, the residual momentum profits do not reverse in the long run (up to three years), supporting the investor underreaction hypothesis. Further analysis reveals that residual momentum is priced in the cross-section of stock returns whereas the Carhart (1997) momentum factor is found to be redundant for describing average stock returns.

Volatility Clustering at a Sector Level in the Chinese Equity Market

The issue of volatility clustering i.e., if periods of high volatility on stocks returns are typically followed by other periods of high volatility and vice versa, is analysed in this article at a sector level for the Chinese stock market. This analysis was performed with daily returns for the period from 2008 to 2017. When the entire dataset is analysed the statistical tests are rather consistent indicating that there is volatility clustering for all the major nine sectors (basic materials, communications, consumer cyclical, consumer non-cyclical, energy financial, industrial, technology and utilities). However, when each year is analysed independently the results are much more mixed with some sectors, such as technology companies, that could a priori look as a prime candidate for volatility clustering having less years with such feature present that other sectors such as for instance basic materials. The issue of volatility clustering at a sector level is of clear interest and can be used as another tool to optimize portfolio allocations. It is interesting to see that volatility clustering seems to be present when the statistical tests are performed over long periods of time but less so when the timeframe is shortened.

An Empirical Investigation of Risk-Return Relations in Chinese Equity Markets: Evidence from Aggregate and Sectoral Data

This paper investigates the risk-return relations in Chinese equity markets. Based on a TARCH-M model, evidence shows that stock returns are positively correlated with predictable volatility, supporting the risk-return relation in both aggregate and sectoral markets. Evidence finds a positive relation between stock return and intertemporal downside risk, while controlling for sentiment and liquidity. This study suggests that the U.S. stress risk or the world downside risk should be priced into the Chinese stocks. The paper concludes that the risk-return tradeoff is present in the GARCH-in-mean, local downside risk-return, and global risk-return relations.

Barra Risk Model Based Idiosyncratic Momentum for Chinese Equity Market

We propose a different way of constructing an idiosyncratic momentum factor using the Barra Global Multi-factor Risk Model. Also, we examine the properties as well as the performance of this new factor by applying it to the China's stock market. Out analysis shows that the idiosyncratic momentum factor constructed here carries the resemblance of the conventional price momentum factor, but with much lower variance and exposure to the common market factors, such as value, size, and volatility. In the long-short portfolio test for both China's A-Share IMI and CSI 500 Indies, we observe the significant improvement of this factor's return over the conventional momentum. In particular, this factor delivers consistent high returns with a moderate IC increase but a significant IR improvement. The performance results strongly suggest that, compared with the traditional momentum factor, the idiosyncratic momentum factor is more reliable and possesses high predictive power for future stock returns. This factor is a good candidate to replace the traditional momentum factor when constructing an effective momentum strategy for investing in China's stock market.

A Principal Component Approach to Measuring Investor Sentiment in Hong Kong

In light of the increasing integration between China and Hong Kong, this paper develops a new market sentiment index for the Hong Kong stock market by including the CSI 300 index of the Chinese equity market. A threshold regression model using the sentiment index as a threshold variable is estimated to capture the state of the Hong Kong stock market.

Reverse Mergers, Shell Value, and Regulation Risk in Chinese Equity Markets

Using a comprehensive sample of reverse merger (RM) transactions, we examine the effects of China’s IPO regulations on the prices and returns of its publicly listed stocks. During 2007-2015, unlisted Chinese firms paid an average of 3 to 4 Billion RMB for each listed shell, an amount exceeding 2/3 of the median market capitalization of a listed firm. This large shell premium varies over time and is sensitive to regulatory shocks. In the cross-section, a portfolio that longs (shorts) the highest (lowest) estimated shell probability (ESP) firms earns substantial abnormal returns. Adding an ESP-based factor to five common factors improves return attribution and eliminates the notoriously large Size premium. Consistent with theory, ESP also explains the sensitivity of prices to corporate earnings, and predicts the likelihood of firms to undertake major asset restructurings (MARs). We conclude China’s IPO regulations impose a high cost on the functional efficiency of its financial system.

New evidence on economic policy uncertainty and equity premium

Motivated by well-documented observations that the Chinese equity market is dominated by risk-seeking speculators with a behavioural bias, we test the hypothesis that China's economic policy uncertainty (EPU) commands a positive equity premium. We find stocks with higher EPU betas earn higher average returns, and the EPU factor-mimicking portfolio earns significant abnormal returns. Loadings on the EPU factor positively forecast the cross-section of returns on various sets of portfolios or stocks, controlling for macroeconomic and stock market uncertainty factors, conventional risk factors, and firm characteristics. Our findings are complimentary to the recently reported US evidence of a negative premium.

A Note on Conditional Variance and Decaying Rate: Chinese Equity Market

Conventional GARCH based models capture short run dependence structures in financial markets or shocks decaying at a faster exponential rate. However, the present study attempts to model long run dependence or memory in Chinese stock market volatility process by employing autoregressive (p)—fractionally integrated generalized autoregressive conditional heteroskedasticity model, i.e. AR (p)—FIGARCH model; following Bollerslev and Mikkelsen (J Econ 73(1):151–184, 1996) with a shift variable. Apart from FIGARCH (1, d, 1) model, conventional GARCH (p, 0, q) and Integrated GARCH (p, 1, q) based models are also employed in order to ensure comparability across integrated processes. The empirical findings advocate long run dependence structure in volatility process of Chinese equity market, whereby a shock to the future volatility decays at a slower hyperbolic rate. However, the integrated decaying parameter relates more to conventional GARCH (p, 0, q) model after considering structural breaks and foreign exchange rate movements, whereby exponential decaying rate is expected in the equity market. The findings bear strong implications for different market participants in their attempt to comprehend volatility component of the equity market.

Noisy prices and the Fama–French five-factor asset pricing model in China

This paper provides an empirical evaluation of the five-factor model recently presented by Fama and French (2015a) that augments the traditional three-factor model with two new factors related to profitability and investment, taking into account the bias in mean returns induced by noise in prices. Using an extensive sample over the period 1997 to 2015, we find that the five-factor model consistently outperforms the three-factor model in the Chinese equity market. In contrast to the findings in Fama and French (2015a), both value and profitability factors are important, while the investment factor is found to be redundant for describing average returns in our sample. With respect to the double-sorted left-hand-side (LHS) portfolios, the main problem with the five-factor model is its failure to fully capture the high average returns of stocks whose returns perform like those of growth firms that invest conservatively due to low profitability. On the other hand, although we find mixed results in the three-dimensional sorting, the LHS portfolios with extremely low average returns are those that cause serious problems for the five-factor model.

The Impact of Short Selling and Margin Trading Regulation on Price Efficiency in China

We investigate the impact of short selling and margin trading on measures of price efficiency, characteristics of stock returns distributions, and price clustering in the Chinese equity market. Short selling and margin trading was permitted on selected stocks from March 31, 2010 and was subsequently extended to further securities in December 5, 2011. First, we find that the regulation change does not have a consistent impact on various price efficiency measures. Second, lifting short-sales constraints significantly reduces skewness. Third, the avoidance of numbers ending in 4, which is considered as unlucky, has marginally been reduced following the regulation change.

Risk–Return Relationship in BRIC Equity Markets: Evidence from Markov Regime Switching Model with Time-varying Transition Probabilities

A rich literature supports the existence of both positive and negative relationship between the risk and return in the developed equity markets. However, the present study attempts to capture the risk–return relationship in the most promising and opportunities-instilled emerging market club, the “BRIC” equity markets, by employing a Markov regime switching model with time-varying transition probabilities, further taking St. Louis Fed Financial Stress Index (the US financial market stress) as an economic variable. The weekly benchmark index values are used in the analysis, spanning from the year 2004 to 2013. The results report the existence of time-varying transition probabilities with respect to the Brazilian and Indian markets only and fixed transition probabilities for the other countries undertaken. The Markov results support the existence of two regimes, wherein regime-1 reports a positive risk–return relationship, and regime-2 reports a negative relationship between the risk and return. Ironically, the Chinese equity market is found to be the riskiest but a perfect hedge instrument amongst others, considering its risk–return interactions in both the regimes. Furthermore, a lower level of financial stress in the US financial market is associated with a higher probability of remaining in the “Bullish” regime-1 in the Indian market as well as Brazilian market. Moreover, there is a positive co-movement between the US financial stress and the expected time-varying duration of remaining in the “Bearish” regime. This shows that due to the growing interdependence among the worldwide economies, a financial stress in one economy does have an impact on the other markets and risk–return relationship in their equity markets. An understanding of the risk–return dynamics coupled with the impact of exogenous variables is an imperative task that a portfolio manager must undertake so as to justify and manage the investments made in the equity markets.

Optimal Sharpe ratio in continuous-time markets with and without a risk-free asset

In this paper, we investigate a continuous-time mean-variance portfolio selection model with only risky assets and its optimal Sharpe ratio in a new way. We obtain closed-form expressions for the efficient investment strategy, the efficient frontier and the optimal Sharpe ratio. Using these results, we further prove that (ⅰ) the efficient frontier with only risky assets is significantly different from the one with inclusion of a risk-free asset and (ⅱ) inclusion of a risk-free asset strictly enhances the optimal Sharpe ratio. Also, we offer an explicit expression for the enhancement of the optimal Sharpe ratio. Finally, we test our theory results using an empirical analysis based on real data of Chinese equity market. Out-of-sample analyses shed light on advantages of our theoretical results established.

The meltdown of the Chinese equity market in the summer of 2015

We study the Chinese stock market crash of 2015. We find that Chinese investors overreact to the government policies that may boost the stock market. This overreaction creates the equity bubble and eventually results in the stock market crash. We also find that fiscal policies excite the equity market more than monetary policies.