Volatility in Chinese Stock market



Volatility in Chinese Stock market

Introduction

Harvey reports that emerging markets have high average returns, low overall volatility, low exposure to world risk factors, and little integration. He concludes that emerging markets are less efficient than developed markets and that higher return and lower risk can be obtained by incorporating emerging market stocks in investors' portfolios. From a U.S.-based investor's point of view, it is important to understand the potential portfolio implications of investing in stocks in these countries. Additionally, it is desirable to understand the behavior of the major equity performance indicators for these countries over time.

China's stock markets attract foreign investors' attention because of that country's fast development and potential opportunities. Since the establishment of the Shanghai Stock Exchange on December 19, 1990, and the Shenzhen Stock Exchange on July 3, 1991, China's stock markets have expanded rapidly. By December 31, 1997, China had 720 A-share listed stocks, of which 372 traded on Shanghai and 348 traded on Shenzhen, and 101 B-share listed stocks, of which 50 traded on Shanghai and 51 traded on Shenzhen. A-share stocks are traded among Chinese citizens and B-share stocks are traded among non-Chinese citizens or overseas Chinese. Total market capitalization exceeds $200 billion, or nearly one-fifth of the country's gross domestic product. Daily trading volume typically hits 750 million shares. China will, therefore, provide a major investment avenue for international and global investors after its accession to the World Trade Organization (WTO). One concern international investors have, however, is the lack of knowledge of China's markets. Institutional characteristics of China's markets differ from those in other countries, so that the research results from other countries cannot be automatically extended to China. One distinguishing feature of China's markets is that some shares are restricted to domestic investors and others are restricted to foreign investors.

In this study we characterize the dynamics of stock returns and conditional volatility in China's stock exchanges. We focus on whether stock returns follow the random walk hypothesis in China. Also, we examine whether stock return volatility changes over time and whether it is predictable. We then study the relation between market risk and expected return. Finally, we examine whether daily trading volume used as a proxy for information arrival time has significant explanatory power for the conditional volatility of daily returns.

Many studies examine whether stock returns are predictable from the past. One hypothesis widely tested is that stock prices follow a random walk, which implies returns are independent. Lo and MacKinlay and Poterba and Summers provide empirical evidence against the random walk hypothesis for stock returns in the U.S. stock markets. Recently, the attention of research has shifted to recognizing the possibility of long-term dependence of returns. Lo conducts long-memory analysis for stock prices.

Financial economists study returns and conditional volatility of stock markets extensively. Baillie and DeGennaro study the dynamics of expected stock returns and volatility in the U.S. stock markets; Poon and Taylor investigate the same relation in the ...